(2 rânduri libere, 11p)
Studies and Scientific Researches. Economics Edition, No 25, 2017 http://sceco.ub.ro
34
THE SAVINGS-TRADE-FISCAL GAP MODEL: APPLICATION
IN SELECTED WEST AFRICAN STATES
Obukohwo Oba Efayena
Department of Economics
University of Nigeria, Nsukka, Nigeria
economix4life@gmail.com
Ngozi Patricia Buzugbe
Department of General Studies
Delta State Polytechnic, Ogwashukwu, Nigeria
buzugbengozi@gmail.com
Abstract
With most African economies experiencing adverse economic misalignment in recent times, the
need of enhancing the growth process cannot be overemphasized. Using a typical Savings-Trade-
Fiscal Gap Model, the paper employed panel data estimation method to examine the impact of
savings, trade and fiscal gap on economic growth of 15 West African countries. The paper finds
a negative relationship between net trade and economic growth, while savings and government
expenditure impacts positively on economic performance. The paper thus, among recommended
that it is appropriate for all countries to eliminate fiscal dominance from monetary policy-
making, reduce public debt and establish institutions that promote and encourage counter-
cyclical fiscal policy, develop their financial systems, establish credibility in fiscal and monetary
policy-making as well as encourage trade.
Keywords
fiscal gap; fiscal policy; panel; growth; savings; capital
JEL Classification
H51; I32
Section title Introduction
A general belief held in modern society is that economic growth hinges on an effective
and efficient financial sector that attract domestic savings and mobilizes funds from
external sources. Without such a fulcrum in place, productive project remains
unexploited. Because the financial institutions in most developing economies
especially in African are inefficient, growth level has been cut higher levels given
appropriate policies. While the financial sector is given much priority in most of such
economies, the trade (local and international) and fiscal sectors have received reduced
attention in the past. Experiences have so far shown that the need for a saving, trade
and fiscal model cannot be overemphasized given the failure of most financial
institutions in developing economies.
This paper will thus examine the empirics of the 3-gap model of savings, trade and
fiscal trends. Following the introductory part, Section 2 develops the typical 3-gap
model, Section 3 shows an empirical application of the model to the Nigerian economy,
while Section 4 concludes and offer policy recommendation.
THE SAVINGS-TRADE-FISCAL GAP MODEL: APPLICATION IN SELECTED WEST AFRICAN STATES
35
The model
In a typical developing economy, four flows are identified which include private savers
and investors, the financial system, the government, and the foreign sector. It is
assumed that private saving is channeled to higher bank deposits, increases in the stock
of narrowly defined money, or asset holdings abroad through capital flight. The
financial side of the economy is treated as a pure credit banking system. This can be
clearly seen in the Chenery and Strout Two-Gap Model.
Following assumption of Rostow (1956) let
p
A be bank assets (credit, loans) advanced
to the private sector,
g
A be advances to the government, and
R
e be the values of
foreign reserves. Bank liabilities are deposits (D) and narrow money (M). Therefore,
the banking system balance sheet is;
p g R
A A e D M (1)
Analyzing equation (1) in flow terms,
. . . . .
p g
A A eR D M (2)
Where a “dot” over a variable denotes its time derivatives,
Savings (s) is some constant proportion, s, of national income (y) such that
S sY (3)
But Investment (I) defined as a change into the capital stock, K, is in accordance with
the acceleration principle measured and assumed to be a constant of the rate of growth
of output so that,
1
( )
t t
I K k Y Y
(4)
I K k Y (4 )a
Where k stands for the marginal capital coefficient or simply the incremental capital-
output ratio (ICOR) and indicates a change in the variable.
Dividing equation (3) by Y yields.
I K Y
k
Y Y Y
(5)
Rewriting (equ. 4) by substituting K for I,
I Y
k
Y Y
(5 )a
Rewriting
Y
Y
as g, the rate of growth of output can be expressed as
1
g
k
(6)
On the assumptions that k is fixed, based on the assumption that the production function
is of fixed proportions, the only constraint to growth is investment capital, hence, is
seen as a bottleneck to growth (Chenery and Strout, 1966). Real Investment I in turn is
the sum of
p g
I I (private and public capital formation). Let
g
I K be the
government’s investment decision. Its own capital formation is set as a share of of
Obukohwo, Ngozi
36
the total capital stock. The value of private investment is ( )g PK and we assume
that the banks issue a new loan
.
p
A to finance the increase in private capital;
.
p
A
g
PK
(7)
The overall investment function determining g is presented as a reduced form
(depending on credit availability among other factors).
Let real government current spending G K
Where as a proxy for the non-investment fiscal deficit or government dis-savings.
The government also borrows abroad. Its outstanding stock of loans is F upon which it
pays an interest rate r. If the debt growth rate F exceeds the interest rate r, the
government turns to the banks to finance the part of its spending it cannot cover with
foreign loans expressed below;
.
g
A
T
PK
(7a)
Domestic borrowing can be a substantial share of GDP when T is less than zero. Debtor
country governments owe large foreign obligations but do not own the resources to
generate foreign exchange to pay. The outcome is a severe fiscal crunch.
Finally on the bank asset side, the increase in reserves is
.
(1 )
e R
T au g Q
PK
(8)
Where
E
K
is the ratio of exports (net of competitive imports) to capital stock.
Imports go only for intermediates goods ( au ) and capital goods (1 )g , and Q
stands for net acquisition of foreign assets (relative to the capital stock) by the private
sector.
To describe the saving gap, we assume that saving desired by nationals in the absence
of price inflation is directed either to foreign asset accumulation or else to increased
bank deposits, such that;
.
(1 )(1 ) ( , )
w
D
Q s s u s u
PK
(9)
Where s and ws are the saving rates from profit and wage income flows respectively.
( )
ea
ea wb
is the share of intermediate imports respectively in variable cost, so
that (1 )(1 )u is the ration of the wage bill to the capital stock. If the share
of saving flows abroad, the equation above becomes;
.
(1 )
D
su
PK
(10)
Putting equation (2) and (10) together shows that the increase in the supply of narrow
money is
THE SAVINGS-TRADE-FISCAL GAP MODEL: APPLICATION IN SELECTED WEST AFRICAN STATES
37
.
.
(1 ) (1 )
(1 )
M
g su au g
PK
e R
g su T
PK
(11)
where the terms in the bracket represent the balance of payments (net of capital flight)
on current and capital account.
Relative to capital stock, we assume that private investment demand is given by the
function;
..
0
( ) ( ) ( )
g gP
I AI D
g au
K K PK PK
(12)
The term au is an instantaneous accelerator, g
I
K
shows that public investment crowds
in private capital formation because of complementarities and other external effects.
The last term
.
( )
g
A
PK
in equation (15) introduces financial crowding-out as a potential
counterpoise to direct crowding-in. It is assumed along conventional lines that
investment is cut back when government puts pressure on financial markets.
Specifically,
P
I falls when a new government borrowing
.
g
A
PK
grows with respect to
the deposit increase
.
D
PK
. The rationale could be that banks raise interest rate and
tighten credit limits more of their deposit base is absorbed by the government. This
simple flow specification is dimensionally equivalent to the quantity theory of money
demand and saves the use of asset stock.
Uniting equation (7), (10) and (12) in its simplified form;
0 (1 ) (1 ) 0g g a s u T (13)
Thus relationship shows that the capital stock growth rate g increases endogenously in
response to greater capacity utilization u due to the accelerator and also because higher
private saving creates deposits which banks use to finance investments.
Government investment has an overall crowding-in effect if
1 .
This condition will be satisfied if
1 And if 1
Also, an increase in foreign transfers T or a reduction in government dis-savings cuts
back on public borrowing from the banks, again permitting private investment to rise.
A third gap, which is the fiscal gap, was also explored for its independent constraining
influence on the growth of an economy. To an extent, a fiscal gap can directly constrain
economic growth, influence the trade gap and therefore make an indirect impact on the
economy. However, the fiscal constraint in a three gap model is often predicted on the
assumptions that the public and private investments (Blejer and Khan 1984; Barro
Obukohwo, Ngozi
38
1989) are complementary to each other and the savings are forced through inflation.
Within the three-gap simulation analysis of foreign resources flows, Taylor (1993)
convincingly concludes that a ‘substantial realignment in international payments would
be required to accelerate the growth for developing nations overall’.
Employing these assumptions in a two gap framework, Bacha (1990) argues that
foreign transfers are more important than foreign savings. This explains why the IMF
and the World Bank continues to emphasize on how to contain the inflationary
pressures through light fiscal and monetary policies. In less developed countries
(LDCs), there exists a market for government bonds however thin it may be while the
governments continues to resort to a partial monetization of budget deficits, they also
access market borrowing thorough open market operations.
Model specification
Analytical framework and empirical model specification
This analysis is carried out within a panel data estimation framework. The preference
of this estimation method is not only because it enables a cross-sectional time series
analysis which usually makes provision for broader set of data points, but also because
of its ability to control for heterogeneity and endogeneity issues. Hence panel data
estimation allows for the control of individual-specific effects usually unobservable
which may be correlated with other explanatory variables included in the specification
of the relationship between dependent and explanatory variables (Hausman and Taylor,
1981). The basic framework for panel data regression takes the form:
Yit = βX
1
it + αZ
1
i + 𝜀it (14)
In equation 14 above, the heterogeneity or individual effect is Zi’ which may represent
a constant term and a set of observable and unobservable variables. When the individual
effect Zi’ contains only a constant term, OLS estimation provides a consistent and
efficient estimates of the underlying parameters (Kyereboah-Coleman, 2007); but if Zi’
is un-observable and correlated with 𝑋it, then emerges the need to use other estimation
method because OLS will give rise to biased and inconsistent estimates.
Similarly for endogeneity issues, it is generally assumed that the explanatory variables
located on the right hand side of the regression equation are statistically independent of
the disturbance 𝜀it such that the disturbance term 𝜀it is assumed to be uncorrelated with
columns of the parameters 𝑋it and 𝑍it as stated in equation (1), and has zero mean and
constant variance 𝜎2𝜂 (Hausman and Taylor, 1981; Nakamura and Nakamura, 1981).
If this assumption is violated, then OLS estimation will yield biased estimates of the
underlying parameters of β (Mayston, 2002).
Hence, endogeneity problems arise when the explanatory variables are correlated with
the disturbance term 𝜀𝑖t (Mayston, 2002; Nakamura and Nakamura, 1981; Hausman and
Taylor, 1981). In order to circumvent these problems, panel estimation techniques of
fixed and random effects will be adopted in this study, in addition to the traditional
pooled regression estimation. Decisions will be made between the fixed and random
effect models using the Hausman specification test.
The panel model for the study is specified thus:
EGit = β0 + β1X’it + µit (15)
Where:
EG = economic growth
X’ = collate of explanatory variables; Savings, Trade and Fiscal gap (government
expenditure)
β0 = intercept
β1 = coefficient of the explanatory variable
THE SAVINGS-TRADE-FISCAL GAP MODEL: APPLICATION IN SELECTED WEST AFRICAN STATES
39
µ = error term
i = cross-sectional variable
t = time series variable (1990-2015)
Interpretation of regression analysis
In this section we employed panel data estimation method to examine the impact of
savings, trade and fiscal gap on economic growth of 15 West African countries (Benin,
Burkina Faso, Cameroon, Cape Verde, Central African Republic, Cote d’Ivoire,
Gambia, Ghana, Guinea, Liberia, Mali, Mauritania, Niger, Nigeria and Senegal) from
1990 to 2015. The study considered the pooled regression assuming that the intercept
is equal across the countries areas and years. We also assume different intercept for
each country and perform both Fixed and Random Effect regressions. This is presented
below;
Table 1 Panel Results for the Savings-Trade-Fiscal Gap Model
Variable Pooled Fixed Effect Random Effect
AS 0.502** 0.617** 0.813**
NT -0.037 -0.015* -0.009
GE 0.037 0.030 0.027*
Cons 0.452** 0.719* 0.274*
No. of Obs 15 15 15
R-Square 0.3598 0.2941 0.4571
F-Statistics (p-
value)
6.28 (0.011) 4.93 (0.066) 17.31 (0.008)
Hausman 0.83 (0.8821)
Note: *, **, *** indicate significance at the 10%, 5% and 1% levels of significance respectively
Source: EView 8 Output
Table 1 above presents the relationship between savings, net trade and government and
economic growth in 15 West African states. The F-statistics value of 6.28 (P<0.05),
4.93 (P<0.05) and 17.31 (P<0.05) show that the independent variables are jointly
statistically significant in the Pooled, Fixed and Random estimates in explaining
variations in economic growth. The R-square statistics value of 0.3598, 0.2941, and
0.4571 shows that the independent variables jointly account for about 35.9%, 29.4%
and 45.7% variation on economic growth in the Pooled, Fixed and Random effect
models respectively. Going by the Hausman test statistics of (0.83) we accept the null
hypothesis that differences in coefficient of the fixed and random estimates are not
systematic, thus we accept and interpret the random effect model.
From the results presented below, a negative relationship exist between net trade and
economic growth, while savings and government expenditure impacts positively on
economic performance in selected West African states. However, only total savings and
government expenditure are significantly related to economic performance. This
relationship is statistically significant at 10 % and 5% level respectively.
The results above have certain economic implications. For one, aggregate savings and
government expenditure in both economies have positively influenced the growth
process, but the trade gap has not been favorable. There is a high possibility that both
economies import more than they export thus leading to an unfavorable balance of
trade. This calls for improved external sector (foreign trade) policies.
Obukohwo, Ngozi
40
Concluding remarks
With the Savings-Trade-Fiscal Gap model fully explained and applied to selected West
African economies, it is appropriate for all countries to eliminate fiscal dominance from
monetary policy-making, reduce public debt and establish institutions that promote and
encourage counter-cyclical fiscal policy, develop their financial systems, and establish
credibility in fiscal and monetary policy-making. There is also urgent need to encourage
international trade in terms of improved exports. This will result in increased
exportation of goods and services which in the long-run will improve the economy. It
is imperative to apply the Savings-Trade-Fiscal Gap Model in a typical economy.
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