SAJEMS NS 7 (2004) No 2 299 Trade Openness and Economic Growth in Nigeria: Further Evidence on the Causality Issue ________________________________________________________________ Saibu Muibi Olufemi Department of Economics, Obafemi Awolowo University ________________________________________________________________ ABSTRACT The study specifically investigated the causality between the openness variable and economic growth, using data from the Nigerian economy. Previous studies in Nigeria have interpreted the regression results of output variables on the export trade variable as providing support for trade liberalization as engine for growth with less emphasis on other measures like import. Such an interpretation is questionable, since these regressions provided no means for determining the direction of causality. This paper performed causality tests with various forms of openness measures and economic growth. The results indicated a uni- directional relationship between openness and growth. This shows that an increasing level of openness will be beneficial, depending on the level of economic development in Nigeria. The result is robust across different measures of openness and analytical techniques. JEL F14, 43 1 INTRODUCTION The idea that trade openness affects economic growth is not new again. However, the nature of the effect is being seriously debated in the literature. Some empirical studies have identified a positive linkage between a country’s rate of economic growth and its openness to international trade, while others have failed to demonstrate such linkage, (Jin, 2002; Sinha & Sinha, 1996). The crux of the differences in these results has been the differences in methodology as well as the way the openness variables were defined (Baldwin, 2002 and Ajayi, 2003). Most striking fact about the existing volume of studies is that despite the fact that both exports and imports are equally important in promoting economic growth, most researchers have focused attention on the former (Sinha & Sinha 2003, Jonsson & Subramanian, 2001). A developing country like Nigeria is SAJEMS NS 7 (2004) No 2 300 import dependent, therefore, its import effects on the growth process should not be ignored or assumed away without any empirical basis. Also, Nigeria has experimented with different exchange rate regimes, which might have implications for the trade-growth nexus. More importantly, with exception of Odusola and Akinlo (1995), no other studies on the Nigerian economy examined the causal relationship between trade (openness) variables and economic growth. The neglect of the causality nexus has implication on the correct modeling of the trade-growth equation. A causality test could provide insight on whether a single or simultaneous equation model is appropriate for trade-growth relationship. The fact that trade volume and economic growth are in tandem revealed nothing about the causal direction. Therefore, the issues of causality between trade and economic growth need to be investigated. This paper essentially contributes to existing studies in three ways: First, the paper included new time series from 1993 to 2000, which were excluded in the earlier studies on the Nigerian economy. The period of 1993 to 2000 coincided with the period when the external trade and exchange rate were extensively liberalized (see figures1 & 2) and thus could have implication on the empirical results. Second, rather than using the common narrow definition of openness, this paper used a variety of measures of trade openness and this helped to check the robustness of the causality results. Third, both VECM and standard granger causality tests were used. This was done to check whether omission of the error correction channel of influence in the granger causality test has any implication on the results. Therefore, this paper not only extended the existing literature but also improved the quality of the evidence. The structure of the paper is as follows. Section 2 examined the trend of trade openness and economic growth over the years. Section 3 provided a review of the existing studies. Section 4 presented the methodology while section 5 analyzed the empirical results. Section 6 concluded the paper with policy implications of the findings. 2 TRADE OPENNESS AND ECONOMIC GROWTH IN NIGERIA The analysis of the growth of exports and imports gives an indication as to the extent of the openness of an economy. However, trade flow analysis provides the basis of robust empirical investigation of the openness of an economy. Empirically, openness can be measured by the share of trade (import plus export) in total output, measured by the Gross Domestic Product (GDP). This is a broad concept of openness; in the narrow context, the ratio of imports or exports to GDP can represent the degree of openness of an economy. SAJEMS NS 7 (2004) No 2 301 A cursory look at Figure 1 shows that the Nigerian economy has been relatively more open since 1986, as a result of policy measures applied under the structural adjustment programme. The broad measure of openness, total trade to GDP (TT/GDP) increased from 0.21 in 1986 to 0.64 in 1987 as a result of the consistent implementation of adjustment measure. In 1990, there was an upward trend in openness when the index reached 1.72. The situation further improved from 1995 when the index rose to about 17.0 because of a policy of deregulation that was re-introduced. The most important factor responsible for the upsurge in the trade volume and the phenomenal increase in the openness index was the final removal of other restrictions on trade as a final measure of the Nigerian government in becoming a member of the World Trade Organisation (WTO) in 1995. This led to increased trade relations with other countries. At the end of 1999, the index of openness reached a remarkable level of 17.6 from 1.1 in 1989. Figure 1 Aggregate output growth and trade openness in Nigeria, 1970- 2000 -10 -5 0 5 10 15 20 25 19 70 19 72 19 74 19 76 19 78 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 YEAR GDPGR TT/GDP SAJEMS NS 7 (2004) No 2 302 While the economy has recorded remarkable progress in improving trade relations with other countries as reflected by the increasing rate of total trade to GDP, the rate of economic growth has remained sluggish. The low correlation depicted by the graph between the openness of the economy and the growth rate of the economy showed that openness has not contributed much to economic growth in Nigeria. In other words, Nigeria has not benefited as expected from the liberalization of the economy. Though, the above trend analysis is informative and indicative of the inverse relationship between economy growth and external trade in Nigeria, definite statements cannot be made without any empirical basis. The subsequent sections examined the empirical relationship between economic growth and openness in Nigeria. 3 REVIEW OF RELATED STUDIES The relationship between openness and economic growth in developing economies has been fully analyzed by a large number of empirical papers. Primary attention has been given to the role of exports in economic performance with little attention paid to other growth promoting openness variables. In their paper, Cuadros, Orts and Alguacl (2001) employed a VAR model to examine the causal relationship between output level, inward Foreign Direct Investment (FDI) and trade in Argentina, Brazil and Mexico. They found that though FDI had significant impacts on growth, their results failed to find evidence in support of export led growth. They concluded that the fragility of their result may stem from the omission of other relevant mechanism through which openness can promote growth. Similarly, Goldberg and Klein (1999) had also opined that if capital flow is significant, focusing only on export as proxy for openness may be misleading. Using data from some Asian countries, Sinha and Sinha (2001) also reiterated that omitting import from trade openness measure creates a missing variable bias. Using data from imports and exports to capture openness, they found positive effects of openness on economic growth for some Asian countries. Apart from export, other trade measures have gained prominence in the literature in recent times. For example, Chanda (2001) used an index of capital account openness to show that more developing countries have suffered from opening their economies than not, while Rodrik (1998) as well as Alesina et al. (1994) found no effects of capital account openness on economic growth. With respect to FDI, there is evidence of a positive growth-effect in countries that are sufficiently rich (Blomstriom et al., 1992, Zhang, 2002; Alfaro & Chanda, 2001) and a negative one in low-income countries (Garrett, 2001). Also, Carkovic and Levine (2002) did not find a robust influence of FDI on growth. Studies examining the effects of FDI on countries growth rates, summarized by SAJEMS NS 7 (2004) No 2 303 Durham (2000), were not unanimous in their findings. Similarly, Edison et al. (2002) detailed analysis of the impact of several indicators of financial openness on growth, showed that no robust relationship exists. However, Dreher (2002) using different measures of openness to capture economic globalization found that globalization promote growth but not to the extent that it can reduce poverty. Studies carried out on Nigeria using time series data, has been scanty. Egwaikhide (1994) examined the link between the trade variable (export) and economic growth in Nigeria between 1959 and 1989, using cointegration and error correction methods. This approach is appealing as it could eliminate the problem of spurious estimates, which previous studies ignored. Ekpo (1995) also examined the openness and performance of the Nigerian economy for the period 1970 to 1992 using broad measures of openness. Using the aggregate production model, his analysis showed that capital stock and labour contributed positively to output growth during the period. However an increase in trade share measured by the black market premium rate and trade/GDP respectively, reduced output. Oladipo (1998) extended the Ekpo and Egwaikhide (1994) model. He measured the degree of openness as the ratio of total trade (export + import) to GDP and as the ratio of export to GDP. Based on a sample period of 27 years (1970 to 1996), Nigerian quarterly data, the results showed that when the export/GDP ratio was used as a measure of openness it correlated positively with GDP growth. But, the conventional broad measure (import plus export) to GDP indicated a negative relationship. Olomola (1998) used the endogenous growth model to explore the long-run relationship between openness and economic growth. He adopted Dickey-Fuller and Augmented Dickey-Fuller test to examine the stationarity properties of the variables. Openness was proxied by export/GPD and total trade/GDP for sample period of 1960 to 1998, he found that total trade/GDP, has no significant relationship with long run growth in Nigeria. In recent studies, Akinlo (2003a,b) examined the effects of FDI on economic growth in Sub-Saharan Africa. He found out that FDI had a positive impact on Sub Saharan African economic growth. In addition, both export and stock market development had positive effects. Though, this result is indicative of the possible role openness in the form of inward flows of capital goods could play in a developing sub-Saharan African country, the fact that the analysis was based on panel data makes country specific policy inferences difficult from the evidence. It is possible that individual country result may differ if time series data are employed. Apart from this shortcoming, one other important shortcoming of these studies is that they ignored the causal relationship between SAJEMS NS 7 (2004) No 2 304 trade openness and growth. Their outcomes were monumental but the neglect of the nature and direction of influence between the trade variable and growth, made their results tentative. Some studies have attempted addressing the issue of causality between the trade variable (especially export) and economic growth. Jung and Marshall (1985) used time series data to perform Granger (1969) causality tests between export and growth for 37 developing countries. The results provided evidence in favour of export led growth in only four instances. The result showed that the export promotion hypothesis is weaker than what previous statistical studies have indicated. Kunst and Mario (1989) also investigated the causality between productivity and exports using quarterly data for the period between 1965 and 1985. The result indicated no causal link from export to productivity. Muhammed and Sampath (1999) also empirically examined the causality between exports (as a measure of trade openness) and economic growth for 97 countries using data for the period 1960 to 1992. While determining the stationarity of the two variables and their order of cointegration, they found that GDP and exports are integrated of different orders for 36 countries. Among the other 61 countries, for 17 countries, there were no long-run relationship between the two variables, 35 countries showed causality at least in one direction. Uni-directional causality from GDP to exports was reported for 10 countries, from export to GDP for 5 countries and bi-directional causality for 20 countries. Nine (9) countries did not show any causality between GDP and exports at all. One important issue of relevance to this study, is that Nigeria was among the 9 countries without causal relationship between exports and economic growth. The findings were contracted from existing studies. Anoruo and Ahmad (1999) used Johansen’s (1991) cointegration technique instead of the Granger (1969) causality test to examine the causal link between trade openness and economic growth. In the five (5) Asian countries, selected covering 1960 to 1998, they found that both openness variables and economic growth are cointegrated and that there was a bi-directional causality between trade openness and economic growth. Our perusal of literature on Nigeria has not indicated any detailed effort at investigating the causal link between trade variables and economic growth. The only exception was Odusola and Akinlo (1995). They used the traditional Granger (1969) causality test to examine the causal relationship between openness and GDP growth. The set of trade variables considered were export, import, and terms of trade and factor inputs, proxied by gross capital formation and labour force, using Nigerian data over 32 years from 1960 to 1992. The causality analysis using the Granger (1969) test indicated bi-directional causal effects between export and growth, there was a unidirectional relation between SAJEMS NS 7 (2004) No 2 305 terms of trade and exports while imports had causal effects on capital formation only. This result contradicted the Muhammed and Sampath (1999) result on Nigeria despite using the same causality test. However, Odusola and Akinlo's (1995) traditional Granger causality test suffered from two methodological deficiencies. First, the standard test adopted did not examine the basic cointegration properties of the variables. If the variables were cointegrated, their model which incorporated the difference variables, is mis-specified since the lagged error correction term is not included (Granger, 1988). Second, the non- inclusion of the error correction term from the cointegration equation eliminated the long-run information embodied in the original form of the variables. The exclusion of the error correction term also foreclosed the detection of an additional channel of Granger causality through the lagged error correction terms. In view of this, Odusola and Akinlo’s (1995) result could not be regarded as final and conclusive. It would, therefore, be interesting to re- examine the causality between trade openness and economic growth through the yet to be explored (error correction term) channel using data from Nigeria. The fact that none of the existing studies was categorical about the nature and direction of the relationship between trade openness and economic growth makes further analysis imperative. Most importantly, the methodology adopted in these studies cannot capture the complex interrelationship between trade and economic growth. It cannot show the likely long run (feedback) effects that exist among trade variables and economic growth. This paper therefore addressed this empirical issue by employing Johansen (1991) cointegration and VECM procedure (in addition to the standard Granger causality test) with time series data for Nigeria and a larger set of trade variables. This method has been found to perform better than the Granger (1969, 1980) causality approach (Anorou & Ahmed, 1999). 4 DATA AND METHODOLOGY This study used annual data on gross domestic product (TGDP), industrial output (INDGDP) and openness measured by a set of trade openness variables for Nigeria. The data cover the period 1970 through 2000. The openness variable was proxied by a set of five (5) variables: export (EXPT), import (IMPT), and export plus import (TTRADE), exchanges rate premium (EXRT) and net capital inflow (NFCI). Indeed, we are aware of the criticism of using trade volume instead of trade policy as measures of openness (Rodriquez and Rodrik, 1999; Rodrik, 1999 and Jonsson & Subramanian, 2001). As Rodrik also observed, most of the trade policy measures in developing countries, like SAJEMS NS 7 (2004) No 2 306 Nigeria, are of low quality and unreliable. Also Jonsson and Subramanian (2001) had argued that trade openness has two forms, namely trade outcomes and trade liberalization. In view of the inadequate and unreliable consistent time series data in Nigeria trade outcomes measures become more appropriate. Therefore, this paper utilizes the trade outcome to measure openness. All the data are collected from Statistical Bulletin and Annual Report and Statement of Account published by Central Bank of Nigeria (CBN, 2001). Cointegration procedure requires time series in the system to be non-stationary in their level. Similarly, it is imperative that all time series in the cointegrating equation have the same order of integration. Consequently, the study first ascertained the time series properties of all the variables. We employed the augmented Dickey-Fuller test for stationarity; the equation estimated for the Augmented Dickey-Fuller test is as follows: ∆ ∆x x t xt t t i i n t t= + + + +− = −∑α β ∂ θ1 1 1 1 1l ... Where, ∆ is the first-difference operator; t is the time trend, and l t is the stationary random error, n is maximum lag length. Xt is total output (tgdp), industrial output (indgdp), and export (expt), import (impt), exchange rate premium (exrt), net capital inflow (nfci) and sum of import and export (ttrade),. To ascertain the long run relationship between economic growth and openness, the Johansen cointegration procedure is utilized (Johansen, 1991) and Johnsen and Juselius (1990). The procedure involves the estimation of a vector error- correction model (VECM) in order to obtain the likelihood-ratios (LR). The VECM used in the study is as follows: ∆ ∆y y yt i m i t i t k t= + + + = − −∑θ θ α β0 1 2' .l .. Where, ∆ is the difference operator, ∆Y is total output (GDPt), industrial Output (indgdp), and export (expt), import (impt), exchange rate premium (exrt), net capital inflow (nfci) and sum of import and export (ttrade)], θ0 represents the intercept, and l t represents the vector of white noise process. The matrix ∃ consists of r (r