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RP 103O C T O B E R 2 0 0 0

THE EFFECT OF EXPORTEARNINGS FLUCTUATIONSON CAPITAL FORMATIONIN NIGERIA

G O D W I N A K P O K O D J E

tA F R I C A N E C O N O M I C R E S E A R C H C O N S O RT I U M /

C O N S O R T I U M P O U R L A R E C H E R C H E E C O N O M I Q U E E N A F R I Q U E

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The effec t o f exp or t earn in ĝ̂f luc tua t ions on c ap i t al

format ion in Niger ia

By

Godwin AkpokodjeNigerian Institute of Social andEconomic Research NISER)

Ibadan, Nigeria

AERC Research Paper 103African Economic Research Consortium, Nairobi

October 2000

I D S

0 3 0 9 3 5

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© 2000, African Economic Research Consortium.

Published by: The African Economic Research C onsortiumP.O. Box 62882Nairobi, Kenya

Printed by: The Regal Press Kenya, Ltd.P.O. Box 46166Nairobi, Kenya

ISBN 9966-944-27-3

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Contents

List of tablesList of figures

1. Introduction 1

2. Exports and investment connec tion: Historical evidenc e 3

3. Review of the literature 7

4. Metho dology 10

5. Emp irical results 14

6. Policy lessons and conclusion 20

Notes 21 References 21 Appendixes 24

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List of tables

1. Nige ria's export earnings and dome stic investment 52. Uni t root test statistics 14 3. Johansen cointegration test results 154. Long-run aggregate capital stock mod el estimates 155. Short-run overparam etarized mod el estimates 176. Short-run parsimo nious mod el estimates 18

List of f igures

1. Real export earnings and investm ent in Nigeria 62. Nigeri a's real export earnings and investment index 63. Long-run mode l residuals 174. Parsimo nious aggregate mod el results 19

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Abst rac t

This study explored the association between export earnings fluctuations and capitalformati on in Nigeria. Using a reduced form equation built around the flexible acceleratormodel and adopting a cointegration technique, it discovered that the current level ofexport earnings fluctuations adversely impinges on investment (that is, the change incapital stock) in the short run.

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1. Introduction

T he centrality of trade to economic growth and development is now beyond dispute.With the evolution of development economics since the 1950s, a vast body of

knowledge has accumulated assigning a phenomenal role to trade in the developmentprocess.

The neoclassical economists, for example, drawing on historical evidence from thenineteenth century, l ikened trade to an engine of growth (Nurske, 1961). Thischaracterization of the relationship between trade and development was mo dified a decadelater by Kravis (1970), who dubbed trade the handm aiden of growth . However, theperception of the inexorable link between trade and growth is no longer exclusivelyneoclassical; it is now endorsed by economists of almost all persuasions. It is widelyacknowledged, for example, that developm ent requires modern technological inputs oftenembodied in imported capital goods; nevertheless, exports, especially of manufactures,remain particularly crucial to the precipitation and perpetuation of growth (see Asher,1970; Emery, 1968).

But the capacity of trade to engineer growth in developing countries has increasinglybeen undermined by the debilitating effects of fluctuations in export earnings. Developingcountries export mainly primary products, which are characterized by lower price andincome elasticities of demand and supply than manufac tured products. Moreover, a limitednumber of commodities (in some cases only one or two) constitutes total exports, exposingthe countries to the vagaries of a highly volatile international economic environment.Finally, the directio n of trade is concentrated in favour of developed countries, and cyclicalmovements in these countries are promptly transmitted to less developed countries.

Since developing countries import most of their capital goods and because technicalprogress in these countries tends to be of the embodied variety, sustained ability to im port,which is partly a function of stable export earnings, is crucial to sustained economicgrowth. Even when imp orts are not emph asized as a source of technical progress, it isstill the case that developing countries import most of their crucial production inputs.Decreased export earnings or fluctuations in export earnings imply inability to importthese inputs or inability to import them at the time when needed during the productionprocess. Therefore, stability and growth of export earnings will have a strong impact on

economic growth.

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2 R E S E A R C H PA P E R 1 0 3

The objective and rationale of the study

The purpose of the study is to explore the association between export earnings

fluctuations and capital formation in Nigeria. In doing so, the study presents threenovelties. First, the standard transmis sion channels of fluctuations in export earnings ongrowth—hypothesized to deter investment—and the transmission channel of thepermanent income l i terature—hypothesized to ease investment—are taken into accountsimultaneously within an integrated theoretical setting and not, as has generally beendone, within an ad hoc specification. Second, the focus is on the link betwee n fluctuationsin export earnings and the formation of capital, which is mo re direct. Third, the relationshipis tested in a country approach method as opposed to the usual cross-country analyses.

Policy relevance

T he empirical relationship between fluctuations in export earnings and investment inNigeria is still foggy. As a result, the findings of the study are expected to haveprofound implications for policy. For example, if export fluctuation were confirmed toretard capital formation in Nigeria, this would dramatiz e the desirability of acc umulating

foreign exchange reserves to smooth fluctuations in export earnings in the short run.These findings could also serve to bolster current efforts at trade and exchange rateliberalization as a mechanism for mitigating fluctuations in export earnings in the longrun.

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2. Exports and investment con nect ion:Historical evidence

lthough Nigeria's oil earnings were bec oming significant in the late 1960s, the civilwar of 1967-1970 prevented effective a nd full exploitation of the oil resources. A s

such, the historical analysis focuses on three subperiods, 1973-19 78, 19 79-19 85 and

T able 1 shows that real export earnings rose from N362 million in 1973 to N585million in 1974. The export earnings index rose from 33 in 1973 to 53 in 1974.This increase was in response to the terms of trade shocks occasioned by the dramaticrise in oil prices in 1973/74. The terms of trade index during this period rose from 21 i n1973 to 51 in 1974 (see Oyejide, 1997).

Part of the domestic w indfall was invested, so that between 1974 and 1978, investmentincreased massively. Table 1 shows that real investment increased from N396 million in1973 to N67 0 million in 1977, while the index of investmen t rose from 127 in 1973 to215 in 1977 (see also figures 1 and 2).

he fall in the quantity and price of oil exports in 1978 resulted in a decline in realexport earnings from N564 million in 1977 to N520 m illion in 1979. The rise in oil

prices in 1979 and 1980 came to the rescue, with real export earnings soaring to N644million in 1980. But beyond 1980, the real export earnings of Nigeria declined. Forinstance, as shown in Table 1, real export earnings plummeted from N644 million in1980 to N26 1 million in 1983. Corresponding ly, the export index dropped fro m 59 in1980 to only 24 in 1983. The drop in real export earnings betw een 1980 and 1983 couldbe accounted for by Nigeria's crude oil exports, whose vo lume w as cut in half (see Gelb,

During this period, also, real investment dropped significantly. Table 1 shows thatreal investment declined from N499 million in 1980 to N121 million in 1984, while the

investment index declined from 160 in 1980 to 39 in 1984. The political change in Nigeriafrom military to civilian government is a major factor in the drop in investment. Duringthis period, there was a shift in emphasis from investment to consumption. Imports were

1987-1995.

1 9 7 3 - 1 9 7 8

1 9 7 9 - 1 9 8 5

1988).

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cut through licensing, increased du ties and the introduction of an import depo sit schem e.In 1981, import licensing became more restrictive while inflation rose to more than20 .

1 9 8 6 - 1 9 9 5

major feature of this period was the implementation of the structural adjustmentprogramme. Real export earnings surged from N350 million in 1986 to Nl,098

million in 1990. The increases were the result of the combin ed improve ment in oil andnon-oil exports during the period. Real export earnings declined to N1,024 million in1991 but rose again to Nl, 05 1 m illion in 1992 as a result of the increase in the price andvolum e of oil exports occasioned by the Gulf War. After 1992, real export earnings beganto drop.

Real investm ent began to rise after 1986, a trend that continued until 1990. However,as Table 1 shows, the level of investment from the mid 1980s to early 1990s does notcom pare favourably with investment levels in the 1970s. While the investment indexwas in triple digits in the 1970s, it was double-digit in the 1980s and early 1990s.

Nigeria depends heavily on imported capital goods and raw materials to run her localindustries. On an annual average, imported capital goods and raw materials accountedfor 38% and 30%, respectively, of total imports between 1970 and 1994. This impliesthat about 68% of total imports of the country is used to service local industries. As aresult, fluctuations in export earnings can be expected to undermine the capacity of thecountry to import these critical inputs at crucial moments.

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T H E E F F E C T S O F E X P O RT E A R N I N G S F L U C T U AT I O N S

Tab le 1 ; N ige r i a ' s expor t ea rn ings and domes t i c inves tmen t

5

Period Real export earnings Real investment

Value Index Value Index(million naira) (1990=100) (million naira) (1990=10C

1972 369 34 363 117

1973 362 33 396 127

1974 585 53 319 103

1975 409 37 472 152

1976 490 44 635 204

1977 564 51 670 215

1978 400 36 561 180

1979 520 4 7 468 150

1980 644 59 499 160

1981 457 42 464 149

1982 332 30 381 123

1983 261 24 250 80

1984 270 25 121 39

1985 320 29 141 45

1986 350 32 217 69

1987 583 53 179 57

1988 483 44 145 47

1989 621 57 197 63

1990 1098 100 311 100

1991 1024 93 300 96

1992 1051 96 301 9 7

1993 902 82 335 108

1994 687 63 281 90

1995 577 5 3 270 87

Source: Computation ba sed on data culled from International Financial Statistics of the IMF, 1996 Edition.

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6R E S E A R C H PA P E R 1 0 3

Figure 1 : Rea l expor t ea rn ings and inves tment in Niger ia

1200

1000

racco

800

600

400

200

Period

Figure 2 : Niger ia ' s r ea l expor t ea rn ings and inves tment index

250

200

150x®TJc

100

Exp index

hv. Index

CN Tfco ena> enPer iod

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3. Review of th e literatu re

Theoretical review

K eynes (1936) was the first to call attention to the existence of an independentinvestment decision in the economy. He observed that investment depends on theprospective marginal efficiency of capital relative to some interest rate that reflects theopportunity cost of the invested funds.

After Keynes, the evolution of investment theory was linked to simple growth mode ls.These models gave rise to the accelerator theory, which makes investment a linearproportion of changes in output. The flexible accelerator model is a more gene ral formof the accelerator model.

Other investment theories include the neoclassical model developed by Jorgenson(1967) and Jorgenson and Hall (1971) and the Q theory associated with Tobin (1969).The notion of irreversibility in investment has also been given considerable attention inthe investment literature (see Pindyck, 1988; Bertola and Caballero, 1990). Finally, thefinancial intermediation theory associated with McKinnon (1973) focuses on the role offinancial deepening and high interest rates in stimulating growth in developing countries.

Empirical review

rect empirical investigation of the relationship between export earnings fluctuationsand investment is scanty in the literature. Rather, the literature is saturated with

empirical work on the connection between export earnings fluctuations and economicgrowth, which is more indirect.

The finding s of the studies on the relationship between fluctu ations in export earningsand economic growth can be categorized into three.

One category of scholars finds a negative association between export instability andeconomic growth, stressing the negative consequences of the former on output throughthe induced uncertainty in long-term planning as well as through shortages of inputs atcritical times during the production process (e.g., Kenen and Voivodas, 1973; Glezako s,1984; Stordel, 1990; Gyi mah -Brem pong , 1991). The works of Stordel (1990) andGyimah-Brempong (1991) are of particular relevance.

Gyimah-Brempong (1991) conducted his study for a cross sample of 34 sub-SaharanAfrica n countries during the 1960 -1986 period. Using a neoclassical growth equation

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with export growth and an export earnings fluctuations index as additional explanatoryvariables, and adopting three different indexes of export earnings fluctua tions, he foundthat the coefficients of the fluctuatio n indexes were significantly negative, thus confirmingthe negative impact of export earnings fluctuations on the growth rates of the sub-SaharanAfrica n economie s. The limitation of this study, however, is that it is cross-sectional.

Stordel (1990) focuse d on the direct relationship betwe en export earnings fluctuationsand capital formation (the majo r determinant of economic growth) using a country-specific

approach for 12 developin g countries during the period 196 3-1983 . Export earningsfluctuation was found to directly harm investment in 7 of the 12 developing countriesexamined. It was particularly significant for the countries characterized by a smalldomestic market and a strong dependence on exports of very few primary commoditiesor unprocessed goods.

Another class of contributors finds a positive relationship between export earningsfluctuations and econom ic growth. The premise here is that developing countries respondto export earnings fluctuations by cutting back consumption. This process, if repeatedover a considerable period of time, increases savings and hence the rate of investment(see Savvides, 1984).

The third group of scholars finds no significant relationship between export earningsfluctuations and economic growth. They argue that developing countries are able toanticipate fluctuations in export earnings and therefore institute contingency plans tocushion such fluctuations; hence fluctuations in export earnings have no appreciableeffect on econom ic growth (see Coppo ck, 1960; MacBean , 1966; Obidegwu andNziramasanga, 1981).

Coppock (1960) was the first to examine the relationship between export earningsfluctuatio ns and econo mic growth. His results show no correlation betwee n exportearnings fluctuatio ns and gross national product (GNP ). He also surmised that the degreeof fluctuations in export earnings is greater in developed than in developing countries.This conclusion was also reached by MacBean (1966).

Two major flaws are inherent in the work of C oppock. First, his fluctuation index isconsidered a random estimate. Second, by using total GNP growth rates rather than percapita growth rates, he introduced an up ward bias into the rates of the developing countries.

Mac Bean's (1966) findings are similar to those of Coppock. How ever, he did not giveattention to the connection between investment and export earnings fluctuations.

Deaton and Miller (1996) note that the policy implica tions of trade shocks (which arein most cases temporary) experienced by sub-Saharan African countries have been thesubject of debate for decades (see Gavin, 1993). A prime concern has been whethertemporary shocks induce an efficient savings response. Collier and Gunning's (1995)conclusion is in the affirmative.

Oyejide (1997) characterized Nigeria's oil boom experience as a mixture of positiveand negative shocks. The positive elements of the shocks came in 1973/74 and 1979;they were mild and short-lived. The negative shock occurred during 1977/78 and againin 1978/79. This shock was deeper and muc h more long lasting. The author observedthat the governm ent viewed the 1973/74 trade shock largely as a permanent phenomenonup to around 1977. However, the sharp decline of oil revenue between 1976 and 1978

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T H E E F F E C T S O F E X P O RT E A R N I N G S F L U C T U AT I O N S 9

provided an important lesson of experience that forced government to give somerecognition to the short-lived nature of the oil boom p henom enon. Accord ing to theauthor, referenc e to a 'wasting asset' and the need to transform its resources into some'permanent' forms by quickly expanding the economy's productive capacity and buildingup its infrastructures are important clues to the gradually changing perception of thetrade shock and resulting oil boom as temporary events which were generating windfallincomes that if wisely expended could create a future stream of permanent income(Oyejide, 1997:123).

Deaton and Miller (1996) established that increase in export prices significantly raisedoutput in the year of the shock. However, such g ains were discovered not to be persistentin the post shock period because they d id not reflect increases in the capital stock.

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4. Methodology

Measurement of export earnings fluctuation index

number of statistics have been used to measure export earnings fluctuations. Anapproach known as the least square method involves fitting a function of time to

export earnings (see Naya, 1973). Another approach is the log variance method. Thisapproach closely approximates the average year-to-year percentage variations in earningsfrom exports of goods and services adjusted for a constant percentage trend. The indexequals the antilog of the square root of the logarithmic variance of the series. In thismethod, the expectation component is determined exclusively by the first and lastobservation. A major weakness of this approach is that the index is highly sensitive tothe particular period chosen by the researcher. The complexity of the method is anotherinherent flaw.

The mo ving averag e method is yet another technique that has been widely used in theliterature. It involves fin ding a moving n orm or trend that yields deviations f rom a trendthat appropriately balance over a short period of time (see Fleming et al., 1963; MacB ean,1966).

This study used the standard normalization co mbined with a movin g average approach.Export earnings fluctuation (F) is derived applying the following formula:

X.-X4. 1 ^with CD

° H j=t-3

whe re X is the export earnings and o 4 is the standard deviation of the export earningsof a four-year period. The advantage of this method is that it distinguishes between riseand fall, temporary and permanent, and stochastic and predictable changes, all relativeto the most recent experien ce in the indexes obtained. (See Appendix A for definitionsof variables.)

Model specification

The shortcom ings attendant on the application of the strict version of the neoclassicalinvestment model as outlined by Jorgenson (1967) and Hall (1977) are abundantly

demo nstrated in the literature (see Galbis, 1979; Wai and Wong, 1982). Consequen tly, a

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T H E E F F E C T S O F E X P O RT E A R N I N G S F L U C T U AT I O N S 1 1

modified version that draws substantially on the works of Blejer and Khan (1984), Stordel(1990), and Sundararajan and Thakur (1980) is adopted in this study.

First, a partial adjustment function for capital stock is specified:

with K* >

Bu t AK, = 0 when K* 0,d4 < 0 )(3)

n

(4);=i

where Q* is the expected output and Q is actual output proxied by GDP. This studyadopted the latter approach as several studies conducted on Nigeria using this approach

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1 2 R E S E A R C H PA P E R 1 0 3

obtained robust results (see Egw aikhide et al., 1995). The lag period was limited to twoyears because of the shortness of the study period.

In line with Coen (1971), /3 varies systematically with eco nomic factors that influencethe ability of investors to achieve the desired level of capital stock. Export earningsfluctua tion is postulated as one of such factors and the channel of transm ission is easy toapprehend. Variations in the levels of export earnings fluctuation induce a slowdown orspeed up of the adjustmen t process. For exam ple, when there is a rise in export earnings

fluctuations, investors becom e more cautious before makin g decisions, trying to obtainmore information. This involves time and money, thus slowing down the process ofadjustment. Therefore, the direct influence of export earnings fluctuations on the speedof adjustment is adverse.

The availability of financing is also an important facto r influencing the coefficient ofadjustment. The consensus in the literature is that the quantity rather than the cost offinancial resources is one of the principal constraints to investment in developing countries(see McKinnon, 1973). In these countries, investment is financed predomina ntly throughdomestic savings because of the rudimentary nature of capital markets (see Bhatt andMeerm an, 1978; Mw ega, 1996).

Given the foregoing postulates, the coefficien t of adjustment is expressed as a functionof domestic savings (S) and export earnings f luctuation (F.). This relationship isrepresented as follows:

= r + (VS + SF) ( 5 )K, -K,^ J

{r\ > 0;

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T H E E F F E C T S O F E X P O RT E A R N I N G S F L U C T U AT IO N S 1 3

Estimation technique

time series approach was adopted in order to avoid potentially spurious resultsemanating from the non-stationarity of the data series and to analyse the short-run

dynamic structure of the relationship. Engle and Granger (1987) suggest a two-stepapproach. First, the existence of a cointegrating relationship among the variables inequations 6,7 and 8 is determined by standard cointegration techniques. If the variables

are cointegrated, stable long-run relationships can be estimated using standard ordinaryleast squares (OLS) techniques. Second, the information in the error terms of the long-run relationships is used to create dynamic error correction models. The Micro TSPEconometric Views (E-View) 1994 software was used for estimating the models.

Sources of data

T he data, which cover 1960-1995 for the aggregate model and 1973-1995 for thedisaggregate models, were sourced in the main from international publications forconsistency reasons. Data on export earnings, savings and gross domestic product deriv efrom the International Financial Statistics of the International Monetary Fund (IMF),while sexies on public and private investment w ere obtained f rom the International F inanceCorporation publications of the IMF. Data on gross fixed capital formation were culledfrom the World Tables of the World Bank.

Gross domestic product in constant 1990 prices was used for real output. Annual

export earnings deflated by the GDP deflator served as real exports, while real savingswas defined as nominal domestic savings deflated by the GDP deflator. Real short-terminterest rate was derived by subtracting inflation from the nomina l interest rate on loans.Investment series were generated by deflating the gross fixed capital formation by theimport deflator. Capital stock was computed using the deflated investment series anddefined as the sum of previous gross investment minus the replacement investment.Replacement investment was calculated assuming an annual depreciation rate of thecapital stock of 10%.'

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5. Emp irical results

Unit root tests

ll variables are in log form e xcept real interes t rate and the export earning s fluctuationindex, which have neg ative values. Table 2 lists the unit root test results. The table

shows that capital stock (K), expected output Q*), savings (S) and interest rate (R ) are1(1); that is, they are stationary only at their first difference. How ever, the export earningsfluctuation index (F ) is an 1(0), being stationary at its level.

Table 2 : Uni t roo t t e s t s t a t i s t i c s

Variables ADF test

LogK -1.87ALogK -4.08LogGK -1.75ALogGK -3.22LogPK -2.21ALogPK -4.21LogQ* -1.49ALogQ* -3.38F -3.10LogS -2.39ALogS -3.81LogGS -2.20ALogGS -4.54LogPS -1.98ALogPS -5.21R -2.19AR -3.89

Note: ADF critical value of the series is -2.97.

F, as an 7(0), was not included in the cointegration analysis b ecause by d efinition an

1(0) is not expected to have a long-run relationship with 1(0) series (see Adams, 1992;Taylor, 1993).Table 3 presents the results of the Johansen cointegration tests for the aggregate capital

stock. The table shows that the variables are cointegrated as indicated by likelihoodratios that are greater than the critical values at both 1% and 5 levels, respectively.2

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Tab le 3 : Johansen co ln teg ra t ion t e s t r e su l t s

1 5

Sample: 1970 1995Included Observations: 26Series: LogK, LogQ*, LogS and R

Eigenvalue Likelihood 5% cri t ical % cri t ical Hypo thes i zedrat io value value no of CE(s)

0.60 77.78 68.52 76.07 None**

*(")denotes rejection of the hypothesis at 5%(1%) significance level.LR test indicates cointegrating equation at 1% significance level.

Long-run capital stock regression results

W ith cointegration confirmed for the aggregate capital stock model, the long-runmodel was estimated. The results, which are contained in Table 4, confirm thenegative association between interest rate and the capital stock. However, this asso ciationis not statistically significant. Furtherm ore, the magnitu de of the interest rate's impact onaggregate capital stock is very small. This m ay be due to the large discrepancy prevailingbetwee n the relatively high rates of return on investment in Nigeria and the interest rateson loans, which are kept artificially low by the monetary authorities.

Tab le 4 : Long- run aggrega te cap i t a l s tock mode l e s t ima tes

Modell ing Log(K) by OLSSample : 1970-1995

Variable Coefficient t-value

ConstantLogQ*LogSR

14.14870.78000.0069

-0.0001

9.7161***3.5701***1.9430*

-0.6064

AdjR*= 0.65 F =7.124(0.0008)Schwarz information criterion = -4.125

0=0.103 4 DW =1.92

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1 6 R E S E A R C H PA P E R 1 0 3

The positive effect of savings and output on the capital stock in the long run, asamplified in the development literature, is confirmed by the results of this study. Outputhas a strong positive impact on the capital stock during the period under investigation.Its impact w as also found to be statistically significant. The impac t of savings on aggregatecapital stock was no t discovered to be highly s ignificant in the long ran.

Though cointegration tests could not be carried out for the disaggregated modelsbecause of an insufficient number of observations, the long-run models for private andpublic capital stock were nonetheless estimated. The results, which are contained inAppendix C, tables CI and C2, indicate that output , savings and export earningsfluctuations affect private and public capital stock in Nigeria. The impact of savings onprivate capital stock is significa nt in the long run, but the impact on public capital stockis not.

Short-run capital stock regression results

W ith confirmation that the residuals from the cointegration regression are stationary(see Figure 3), the dynamic version of the long-run model was specified with theresiduals from the cointegrat ion regression as the error correct ion term (EC). Anoverparametarized error correction model was first estimated. Theory dictates that asmany lags as possible should be included in the overparametarized model. However,greater consideration was given to the optimal lag rule for the series. The optimal lagwas determined by minimizing the Akaike info criterion. By this criterion, the optimallag was discovered to be one period. Furthermore, the shortness of the period ofobservation and the need to have sufficient degrees of freedom preclude the inclusion oflonger lag periods.

Stat is t ics and economic theory provided the guide to the parsimonious model .Accordingly, variables whose signs did not conform to economic expectations and thosethat had low t-statistics were construed to be zero.

The diagnostic tests for the overparametarized and parsimonious models, which arecontained in tables 5 and 6, show that the AR test for autocorrelated residuals, the AR CHtest for heterosceda stic errors and the Jarqu e-B era norm ality tests for the distribution ofthe residuals are not significant as indicated by the levels of significance in parentheses.The tables also reveal that the Schwarz cri terion (SC) declined from -7.26 in theoverparametarized model to -8.24 in the parsimonious model.

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Figure 3 : Long- run mode l r e s idua l s

Tab le 5 : Shor t - run ove rpa rameta r i zed mode l e s t ima tes

Modell ing A Log(K) b y OLSSample : 1970-1995


Constant 0 .0001 0.0341A L o g K ( - 1 ) 0 .1635 2.7346***AR -0.0006 -2.0502**A R(- I ) 0 .0002 0 .7045A LogS 0 .0001 0 .0028A L o g S ( - 1 ) -0.0030 -0 .0990A LogQ* -0.0165 -0 .3094A L o g Q * ( - 1 ) 0 .2150 2.1818**F -0.0471 -2.4805**F(-1) 0 .0358 0 .0884EC(-1) -0.5173 2.4205**

AdjR2 = 0.756 F = 2.91(0.0787) a = 0.016 DW = 2.15Schwarz information criterion = • 7.2654

Diagnostic tests:Normality [Chi2(1)] = 1.38(0.78)ARCH F[1,24] = 2.37(0.78)AR 1 -2 F[2,24] = 2.34(2.45)

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1 8

Ta b l e 6 : S h o r t -r u n p a r s i m o n i o u s m o d e l e s t i m a t e s

R E S E A R C H PA P E R 1 0 3

Modell ing A Log(K) by OLSSample : 1970-1995


Constant -0.0008 -0.2605ALo gK(-1 ) 0 .5033 4 .6847***A R -0.0001 -0.2802A L o g S ( - 1 ) 0 .0057 0 .6062ALo gQ*( -1 ) 0 .1780 5 .9049***F -0.0590 -2.9040***EC(-1) -0.4512 -5.9632***

Adj R2 = 0.546 F =12.41(0.00 00)

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Figure 4 : Pa r s imon ious aggrega te r e su l t s g raph

6 -

4 -

2 ...

0 1 1 1 F —f- I-—I • I' • i I 1 — — f — I 1 • I •• •—-f 1 I • -11973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995

Given this premise, increases in export earnings fluctuations should slow the speed ofadjustment. A rise in export earnings fluctuations causes the desired capital stock toplummet in Equation 3. The aggregate impact is a decline in net investment in Equation

2.The coefficient of the error correction term [EC(-l)] indicates the speed at which

aggregate investment adjusts in the long run to its mai n driving force. Table 6 shows thatthe variable is well defined. It is negative and highly significant.

Tables C3 and C4, and C5 and C6 (Appendix C) present the results of theoverparametarized and parsimonious private and public capital stock models. The SCalso declined from -5.69 and -4.35, respectively, in the overparametarized private andpublic capital forma tion models to -6.38 and -6.24, respectively, in the parsimo niousmodels. These declines indicate model parsimony.

The results of the short-run parsimo nious error correction mode ls for the private a ndpublic capital stock contained in tables C4 and C6 , respectively, reveal that savings a ndoutput affect capital formation in both sectors. However, while private savings have asignificant impact on capital formation in the private sector, public savings do notsignificantly affect public capital formation. The tables also reveal that export earningsfluctuations adversely affect capital forma tion in both sectors. The impact is relativelylarger in the public sector, however.

While the results of the private and public capital stock models are appealing, theyshould be taken with some caution. Th is is particularly the case as diagnostic tests couldnot be carried out because of the considerable loss in degrees of freedom arising fromthe calculation of capital stock in both sectors. This is in addition to the small samplesize from which the results were obtained.

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6. Pol icy lessons and conclusion

G ven that export earnings fluctuation was found to adversely affect investment inthe short run, it appears that export stabilization schemes are likely to stimulateinvestment by minimizing the debilitating effect of fluctuations in export earnings in theshort run. However, it should be noted that the impact of such stabilization schemes oninvestment is not anticipated to be very large as a result of the small magnitude of thecoefficie nt on export earnings fluctuations. The small extent of the reaction of investmentto export earnings fluctuations in the short run suggests that other policy instrumentscould have a larger investment stimulating effect. It appears that a change in the officialinterest rate has no effect on investment. However, fiscal policy instruments may havethe largest impact on investment, under the assumption that they affect output directly.

Finally, the small sample size on which the results are based implies that the policylessons are suggestive and therefore should be taken with some caution.

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N otes

1. The entire study period for the aggregate (Equation 6) and disaggregated (Equations

7 and 8) models is 1960 -1995 and 19 73-19 95, respectively. Howe ver theregression period f or Equation 6 is 1970-1995, while that of equations 7 and 8 i s1983-1995. This is due to the 10% rate of capital stock depreciation applied in thestudy.

2. Cointegration tests could not be carried out fo r the disaggregated models becauseof insufficient number of observations.

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Ap pendix A: Defini t ion of v ar iablesp - Adjustment coefficientF Export earnings fluctuation ind exK Aggregate capital stockG K - Pu blic c apital stoc kPK - Private capital stockK * - D es ir ed c ap it al sto ckQ * - Expected outputr Real interest rateS Domestic savingsG S - Public savingsPS - Private savingsX Export earnings

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Appendix C Results of disaggregated mo dels

Tab le C1 : Long- run p r iva te cap i t a l s tock mode l e s t ima tes

Modell ing Log(PK) by OLSSample : 1983-1995


Constant 5.1257 2.6981**

LogQ*LogPSR

1.32250 .5874

-0 .0726

2 .5941**1.9643*

-0 .6548

AdjR*=0.66Schwarz information criterion

F=11.54(0.010)

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Table C5: Shor t - run overparameta r l zed mode l e s t ima tes

2 9

Modell ing A Log(GK) b y OLSSample : 1983-1995


Constant 0.0632 0.2461ALogGK(-1) 0.2147 1.9742*AR -0.0580 -1.6261AR(-1) -0.0009 -1.9806*ALogGS 0.0006 0.2354ALogGS(-1) 0.0204 -0.4360ALogQ* 0.0431 1.9819*ALogQ*(-1) 0.4561 0.4321F -0.0310 -2.5431**F(-1) -0.0042 -0.7861EC(-1) -0.5321 -1.9172*

Adj Rz = 0.76 F = 4.78(0.1032)

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