Trade liberalization is often considered to be conducive to economic growth. In addition to the comparative advantage argument of classical economists, trade liberalization enhances competition, promotes the large market, transfers of technology, and hence efficiency in production. In light of this, most developing countries have embraced the trade liberalization policy as part of their structural reforms. Ghana had gradually liberalized its trade regime, especially after 1986, when the country accepted the World Bank and IMF Structural Adjustment Programme (SAP). The main purpose of the liberalization policy was to open up the economy to increase competition to improve efficiency in domestic industries to enhance economic growth. This study will, therefore, be carried out to find out the impact of the trade liberalization policy on the GDP growth of Ghana from 1986 – 2018.
The study will use the Autoregressive Distributed Lag (ARDL) approach to estimate the model specified for the study. The choice of the ARDL approach is mainly due to the smallness of the sample size. In this study, openness (sum of exports and imports to GDP) will be used as a measure of liberalization. Using annual time series data from 1986 – 2018, the study will find if trade liberalization enhances GDP growth in Ghana in the long run but hampers growth in the short term. Capital stock, population growth, and inflation will also be tested to find its impacts on GDP growth in both the short run and long run, while foreign direct investment will be tested on GDP growth accordingly. The study will recommend that domestic consumers should be encouraged to patronize locally made goods and services. This can be done through the organization of rural trade fairs and exhibitions to bring made in Ghana goods to the doorsteps of the people. It will also recommend that foreign direct investors should be encouraged to invest in the agriculture and industrial sectors.
INTRODUCTION
Background of the Study
The issue of whether trade and increased openness--s should lead to higher rates of economic growth is an age-old question which has sustained debates between pro-traders and protectionists over the years.— from; Adam Smith, David Ricardo, John Stuart Mill, John Maynard-Keynes to Raul Prebisch, Hans Singer, Jagdish Bhagwati, and Paul Krugman. Theorists from both camps have influenced policy in many countries and at various stages of development. Early proponents of free trade lauded the gains from trade that could accrue to countries when they specialize in the production of goods in which they have a comparative advantage and engage in business to meet their other needs. New development theorists contend that openness stimulates technological change by increasing domestic rivalry and competition, leading to increased innovation. Trade liberalization by allowing new goods to flow freely across national borders increases the stock of knowledge for technological innovations that spur growth. The empirical literature shows that trade openness or liberalization affects output growth. Most of the studies have concluded that the openness of the trade regime has a positive relationship with GDP growth. Some of these studies include Ahmed, Y. and Anoruo, E. (2000), Edwards (1992, 1998), Sachs and Warner (1997), Harrison (1996), Iscan, T. (1998), Paulino (2002), Wacziarg (2001), Yanikkaya (2003), among others. When Ghana gained independence in 1957, the country pursued a strategy of import substitution and implemented a series of restrictive trade policies, including increasing tariffs, non-tariffs, and exchange rate controls, which lasted until 1982. The exchange rate was fixed while import quantities were strictly controlled through the Bank of Ghana foreign-exchange allocations (Armah, 1993). Between 1970 and 1982, both import volumes and import to GDP ratio registered continuous declines, and the trend in the export/GDP ratio and the export volume index was downward. The export/GDP ratio fell from 20.7 to 3.6 and the import/GDP ratio fell from 18.5 to 3.3. Again, Ghana's share of world exports declined by 68% during the same period. A large balance of payment deficits developed particularly in the early 1980s such that gross official foreign reserves were depleted and external payments arrears accumulated, amounting to about 90% of export earnings by the end of 1982 (World Bank, 1985).
Furthermore, inflation rates were very high, averaging over 50%. Apart from the 139% devaluation in 1978, the exchange rate was held constant. The high rates of inflation during the period meant that the exchange rate became increasingly overvalued, such that by 1982 overvaluation was estimated at 816% (Werlin, 1994). This restricted trade, coupled with the misaligned exchange rate, eroded the competitiveness of exports while limitation on imported inputs and consumer goods also inhibited export production and production as a whole, causing extremely low capacity utilization (Ghartey, 1987). The economy experienced a negative growth rate for some of the years, particularly between 1978 and 1983, where the annual average real GDP growth rate was –1.34%. The other years, however, experienced positive growth rates though at declining rates (World Bank, 1995). Given the above, the Government of Ghana launched the economic recovery program that included restructuring the physical infrastructure and economic institutions and decreasing inflation through prudent monetary, fiscal, and trade policies. The 1986 trade liberalization program was part of the Rawlings administration's World Bank, and IMF supported Economic Recovery Programme (ERP). The purpose of the liberalization policy was to open up the economy to increase competition to improve efficiency in domestic industries to enhance economic growth. The liberalization policy also aimed at narrowing the gap between the official and parallel exchange rates to provide foreign exchange to ease import strangulation to increase output, particularly in the export sector (Armah, 1993). Multiple exchange rates were initially implemented to promote exports. Included in the liberalization policy were foreign exchange liberalization, import liberalization, and export diversification. To complement reform of the exchange rate system, access to the official foreign-exchange market auctions was gradually widened until there were practically no restrictions on imports into Ghana. The use of import licenses was abolished in 1989 in addition to the removal of quantitative import restrictions. The tariff system was overhauled and adjusted downwards early in the adjustment program. The tariff schedules were 10%, 20%, and 30% compared with schedules of 35%, 60%, and 100% before the period before 1982. On the export side, reforms were introduced in 1991 so that non-traditional exporters no longer had to surrender their foreign-exchange receipts to the Bank of Ghana, although the ruling still applied to gold and cocoa receipts (Jebuni et al., 1994). During the liberalization period, import volumes have increased continuously. The volume of imports increased from US$712.5 million in 1986 (representing 12.43% of GDP) to US$1728.0 million in 1993, also representing 28.51% of GDP. This was partly due to trade liberalization releasing pent-up demand. But it was also due to positive income growth rates and large capital inflows. The decline in the anti-export bias of the trade and payment regime has led to increases in export volumes, particularly in the traditional sectors of cocoa, gold, and timber, although there has been little in the way of export diversification. The volume of exports also rose from US$773.4 million in 1986 to US$1234.70 million in 1994, representing 13.49% of GDP and 22.63% of GDP, respectively. The share of Non-traditional export has also increased, averaging 5.8% between 1986 and 1995. Despite large increases in export volumes, declining terms of trade and a massive surge in externally funded imports required to increase industrial production have ensured a deficit. Meanwhile, real GDP growth from 1986 to the latter part of 1990s averaged 4.5% per annum, average inflation of 29.4% from 1984–1992 and 27.9% in 1993–2000 period. Inflation, however, reached its peak of 59.5% in 1995 (WDI, 2001). It could be concluded from the above that the inclusion of the trade liberalization policy as part of the reform program was a laudable decision. The dominant economic issue, however, is how and how far liberalization of trade enhances the drive to rapid economic growth. The extent of trade liberalization differs among countries due to structural and economic peculiarities. Thus, a specific country analysis of the trade liberalization is justified to have a better understanding of it's (i.e. trade liberalization) impact on GDP growth in individual countries,
Statement of the Problem
The impact of trade openness on economic growth has been the subject of many discussions and studies over the last several decades. This is exemplified in many of the World Trade Organisation (WTO) Rounds. In 1986, Ghana adopted the policy of trade liberalization as part of the reform and adjustment programs of the Breton Wood Institutions. The objective was to open the economy to competition to enhance efficiency in domestic production which would eventually lead to growth in output, reduce the high incidence of the balance of payment deficits and consequently enhance GDP growth. The adoption of the trade liberalization policy was also in response to the poor performance of the external trade sector. Hitherto, Ghana had pursued a strategy of import substitution and implemented a series of restrictive trade policies including increasing tariffs, non-tariff barriers, and exchange rate controls. The restrictive trade saw a decline in the export/GDP ratio and import/GDP ratio from 20.7 to 3.6 and 18.5 to 3.3 respectively particularly for the period between 1970 and 1982. This adversely affected the growth performance of the economy. It was, therefore, the thought of many Ghanaians that the liberalization policy was going to alleviate the external sector of the persistent deficits so that it could play its role in enhancing GDP growth effectively. However, after more than two decades of liberalization of the exchange rate system, import and export diversification, the growth performance of the economy has been between 4.2 % and 5.0% which is less than the targeted growth rate (Aryeetey and Fosu, 2005). Considering the purpose for which the liberalization policy was adopted. Growth performance of the economy and the trade/GDP ratio over the past two decades, the questions that arise are; has the liberalization policy been able to achieve its objective of reducing overall balance of payment deficits to stimulate GDP growth? What have been the trends in real trade balance since liberalization? What has been the impact of other key macroeconomic variables such as inflation, capital, foreign direct investment, population growth, among others on GDP growth in Ghana? This study thus attempts to analyze the impact of the trade liberalization policy as well as inflation, population growth, foreign direct investment inter alia on GDP growth in Ghana.
The objective of the Study
The general objective of the study is to analyze the impact of the trade liberalization policy on Gross Domestic Product (GDP) growth in Ghana from 1986 to 2018.
The specific objectives of the study were:
To examine the impact of other key macroeconomic and policy variables on economic growth.
To suggest appropriate policy measures arising from the empirical findings to support the need for or otherwise of trade liberalization in Ghana.
Hypothesis development
The study seeks to test and validate the following empirical hypothesis
H1: Trade openness does not enhance economic growth.
H2: Trade openness enhances economic growth.
Justification for the Study
It is an indisputable fact that the target of every economy is to attain the highest possible level of growth. A rise in growth usually implies a rise in the aggregate welfare of the people. For this reason, governments of developing countries over the years have been pursuing policies that would lead to growth. The role of the free international movement of goods and services, as well as factors in achieving growth, cannot be overemphasized. Theories, as well as empirical evidence, have shown that trade liberalization and, for that matter, trade openness has a positive correlation with economic growth. Ghana made an early attempt at trade liberalization between 1966 and 1972, which was not successful. However, the policy was again adopted as part of the Economic Recovery Programme (ERP) in 1983 but came into full effect in 1986 with the abolition of all quantitative controls on imports and exports as well as the liberalization of the exchange rate regime. Given the positive relationship between trade liberalization and growth, as shown by theoretical and empirical studies. It calls for an insight into the extent to which trade liberalization has impacted on the GDP growth of Ghana since the country liberalized its trade and exchange rate in 1986. Hence the justification for this study. The study is thus anticipated to help researchers and policymakers to understand the trends and volume of exports since liberalization was adopted in Ghana. The study is also expected to help policymakers in the review and making of new trade policies.
Scope of the Study
Conceptually, this research finds out the impact of trade liberalization on Gross Domestic Product (GDP) growth in Ghana. It includes theoretical and empirical discussions of trade, trade openness, and economic growth. It also gives a background discussion on trade liberalization and export-led growth. The study finally highlights on trade policy and performance in Sub-Saharan African countries. The study was limited to the period 1986 – 2018. This period is chosen because it was during this period that the policy took full effect with the abolition of quantitative control on both imports and exports as well as liberalization of the exchange rate.
Organization of the Study
The study will be organized into five main chapters with each chapter further divided into sections and sub-sections. The first chapter deals with the general introduction to the study. Chapter two reviews both the theoretical and empirical literature on trade, trade liberalization, and economic growth. Chapter three focuses on the specification of the empirical model used for the study. The results of the data collected for the study will be analyzed and discussed in the fourth chapter. The fifth chapter will present the summary of findings, policy implications, recommendations, and conclusion of the study.
Literature Review
Introduction
The literature review focuses on relevant literature on trade and economic growth. This chapter consists will consist of three broad sections. The first section reviews the theoretical literature on trade and economic growth with an emphasis on the traditional explanation of trade and growth, trade and technological change and as well as trade, rivalry, and technological innovation and trade liberalization and export-led growth. Section two deals with the review of empirical work on trade, trade liberalization, and economic growth. The third section presents a review of trade policies and performance in Sub-Saharan African countries.
Explanation of terms
Traditional explanations of trade as "the engine of growth" and the impact of trade on economic development are rooted in the principles of comparative advantage. The theory of comparative advantage arises from nineteenth-century free trade models associated with David Ricardo and John Stuart Mill, which were modified by trade theories embodied in the factor proportions or Hechsher–Ohlin Theory (1933) and Stolper-Samuelson (1941) and Rybzsnski Effects (1955). These trade models collectively and in various ways predict that an economy will tend to be relatively effective at producing goods that are intensive in the factors with which the country is relatively well endowed. In other words, comparative advantage provides that when nations specialize, they become more efficient in producing a product (and indeed a service), and thus if they can trade for their other needs, they and the world will benefit. The figure below captures the essential elements of trade and specialization and related gains using a two-country, two-good model.
Gains from Trade in a Two-country Two-good Model
The model depicts two countries (home and foreign countries) and two goods, food and manufactures before and after a trade. The y-axis depicts the relative price while the x-axis shows the relative output. The home country has a comparative advantage in producing food but also produces manufactures, while the foreign country has a comparative advantage in manufactures but also produces food. Under autarky (no trade), the relative price in the home country is Pm/Pf, facilitating relative supply (RS) of Qm/Qf on the RS curve, and that in the foreign country is Pm/Pf * facilitating the relative supply of Qm/Qf* on the RS* curve. When the two countries trade, the home country exports food to foreign country and import manufactures. The relative price (Pm/Pf) in the home country drops because the price of food (Pf) increases due to the reduced supply of food in the home country while the relative supply of manufactures increases. Changes occur in the foreign country when it imports food from the home country as an increase in food suppliers brings down the price of food, causing the relative price Pm/Pf* to rise in the foreign country. The equilibrium relative price converges at Pm/Pf** on the RS+RS* curve. This is the efficiency price that generates the relative supply of Qm/Qf**, where the home country produces the efficient level of food and the foreign country produces the efficient level of manufactures as a result of trade and specialization. The two countries eliminate unnecessary capacity in their respective economies. Trade has the impact of integrating the two economies since through exchange they produce the economically efficient levels of both food and manufactures.
The principles portrayed in the above model are also in line with the theories advanced in early writings by John Stuart Mill, stating that trade, according to comparative advantage, results in more efficient employment of the productive forces of the world. According to Mill, this was considered as the direct economic advantage of international trade (Meier, 1995). On the other hand, trade restrictions or barriers are associated with reduced growth rates and social welfare, and countries with higher degrees of protectionism, on average, tend to grow at a much slower pace than countries with fewer trade restrictions. This is because tariffs reflect additional direct costs that producers have to absorb which could reduce output and growth. The cost of a prohibitive tariff or quantitative restriction on a hypothetical country and the world economy is demonstrated graphically in Figure 2.2.
With free trade, both foreign suppliers and local producers would be willing to supply country X (a large importer) the combined output of product Q at the world price of Pw. If country X imposes a tariff or quota, however, total demand for product Q is reduced from Q to MQ. This drives down the world market price from the equilibrium price of Pw to the new world price of Pw' while at the same time pushing the price facing local consumers in country X to the higher price of Pt. It can thus be seen that the tariff or restriction is welfare reducing at the global level as it results in lower prices for exporters (who may have to face collapse) while country X's consumers face unjustifiably higher prices at Pt. A narrow group of local suppliers or a rent-seeking monopolist would, however, register again in that due to the tariff or quantitative restriction, they earn a premium of Pt – Pw' and total rents amounting to (Pt – Pw')× OMQ.
Impact of prohibitive tariffs or restrictions
The dynamic effects are that world supply would decline as producers from the rest of the world cut back supply in response to the lower price and the monopolist local suppliers have no incentive to increase output since they can enjoy premium revenues without expanding output. This results in a reduction of overall growth. The model being examined predicts that protectionist measures in the form of tariffs or quotas could lead to reduced output and export growth and overall welfare. The direct implication of these conclusions is that unrestricted trade would tend to be associated with higher levels of growth. Specialization based on comparative advantage enables the maximum level of output to be produced from a given amount of factor resources. Production increases, consumption increases, and therefore global welfare increases. There is nothing in the doctrine of comparative advantage however, that guarantees an equal or equitable distribution of the gains from trade. It depends on the international rate of exchange between the two goods, on what happens to the terms of trade, and on whether the full employment of resources is maintained as resources are reallocated as countries specialize. As to which country a benefit most from specialization depends on how close the international rate of exchange is to the domestic transformation ratio between the two goods. The closer is the international rate of exchange to a country's internal rate of exchange, the less it will benefit from specialization, and the more the other country will benefit. In extreme circumstances, one country may become worse off if the real resource gains from trade are offset by a decline in the terms of trade. This is the case of 'immiserating growth' first demonstrated by Bhagwati (1958). In considering the distribution of the gains from trade between developing and developed countries, the problem for many developing countries is that the nature of the goods that they are 'forced' to specialize in under the aegis of free trade have characteristics which may cause both the terms of trade to deteriorate and the unemployment of resources. Firstly, primary commodities have both a low price and income elasticity of demand which means that when supply increases prices can drop dramatically, and demand grows only slowly with income growth. Secondly, primary commodities are land-based activities and subject to diminishing returns, and there is a limit to employment in diminishing returns activities set by the point where the marginal product of labor falls to the minimum subsistence wage. No such problem arises in manufacturing, such as cloth production, where no fixed factors of production are involved, and production may be subject to increasing returns. The preservation of full employment in both activities, as resource reallocation takes place, implicitly assumes non-diminishing returns in both activities; that is, constant or decreasing costs. In practice, for countries specializing in diminishing returns activities, the real resource gains from specialization may be offset by the real income losses from unemployment. In this case, complete specialization and free trade would not be optimal. Now consider the dynamic gains from specialization and trade. The essence of dynamic gains is that they increase the productive capacity of the economy by augmenting the availability of resources for production through increasing the productivity of resources and increasing their quantity. One of the major dynamic benefits of trade is that export markets widen the total market for a country's producers. If production is subject to increasing returns, export growth becomes a continual source of productivity growth. There is also a close connection between increasing returns and the accumulation of capital. For a small country with no trade, there is very little scope for large scale investment in advanced capital equipment; specialization is limited by the extent of the market.
But if a poor small country can trade, there is some prospect of industrialization and of dispensing with traditional methods of production. It is worth remembering that at least 60 countries in the world classified as developing, and 31 in Africa, have populations of less than 15 million. Without export markets, the production of many goods would not be economically viable.
Other important dynamic benefits from specialization and trade consist of the stimulus to competition; the acquisition of new knowledge, new ideas and the dissemination of technical knowledge; the possibility of accompanying capital flows through foreign direct investment, and changes in attitudes and institutions. In the context of 'new' growth theory, these are all forms of externalities which keep the marginal product of physical capital from falling, so that trade improves the long-run growth performance of countries. Under endogenous models, the growth reflects the contribution to productivity from structural and governance reforms on the one hand and the adoption of new technology on the other. Trade is seen as affecting long-run growth through its impact on technological change. Endogenous growth models, therefore, hold that trade provides access to imported products, which embody that new technology. Additionally, trade alters (mainly increases) the effective size of the market-facing producers which raises returns to innovation; and affects a country's specialization in research-intensive technologies and production systems. These principles reflect what John Stuart Mill had earlier referred to as the important indirect effects of trade which must also be counted as promoting development. These benefits were of three kinds:
Those that increase the extent of the market induce innovations and increase productivity.
Those that increase capital accumulation and savings.
Those that have an educative effect in instilling new wants and in transferring technology, skills, and entrepreneurship.
Mill concluded that if trade increases the capacity for development, then the larger the volume of trade, the greater the potential for development (Meier, 1995). It is important to emphasize that the extent of rivalry and competition is also a key determinant of innovation activities among firms in an economy. Openness and international competition increase rivalry among firms in the domestic economy and with outside producers which stimulates innovation leading to efficient production systems and growth.
By contrast, protectionist policies that restrict trade keep out the competition, and this would result in reduced innovation and slow down growth. A wide range of empirical research has supported the hypothesis that increased international rivalry and competition results in technological innovation. Trade liberalization does not necessarily imply faster export growth, but in practice, the two appear to be highly correlated. The impact of trade liberalization on economic growth outlined in the previous and subsequent sections probably works mainly through improving efficiency and stimulating exports which have powerful effects on both supply and demand within an economy. There are several different measures of trade liberalization or trade orientation, and all studies seem to show a positive effect of liberalization on economic performance. Likewise, there are several different studies of the relationship between exports and growth and the evidence seems overwhelming that the two are highly correlated in a causal sense, but the relative importance of the precise mechanisms by which export growth impacts economic growth is not always easy to discern or quantify. There are several possible measures of trade liberalization or outward-orientation, and many investigators and organizations (e.g. Leamer, 1988; World Bank, 1987) devise their measures. Some of the most common measures used are the average import tariff; an average index of nontariff barriers; exports plus imports to GDP ratio; an index of effective protection; an index of relative price distortions or exchange rate misalignment, and the average black market exchange rate premium. In 1987, the World Bank classified a group of 41 developing countries according to their trade orientation to compare the performance of countries with different degrees of outward/inward orientation. Four categories of countries were identified:
Strongly outward-oriented countries where there are very few trade or foreign exchange controls and trade and industrial policies do not discriminate between production for the home market and exports and between purchases of domestic goods and foreign goods.
Empirical Review
Some economists consider that the liberalization of trade leads to economic development. They believe that inefficient trade policies are caused by the departure from economic theory, its misinterpretation, and mistakes in the policy implementation. Other scholars put the development ahead of trade regime policy: each country has to identify its model of development, then what institutional reforms have to be adopted, where trade regime/liberalization is a part of such reforms. The World Bank found in the 1990s that the increase of trade-to-GDP ratios made an increase of 5 percent of income per capita for about 3 billion people. It concludes that countries which do open up, increase their growth rates. The IMF considers that a low level of trade makes countries more volatile to debt crises. It recognizes that the debt services of the least developed countries are in large due to the low export revenues. The discussions about trade liberalization reached their top in the last few years, especially after the large-scale anti-globalization protests in Seattle, Washington, and Brussels. This is why now more and more researchers incorporate in their papers concerns of various opposition groups to the trade liberalization at all means.
Yanikkaya (2003) estimated the effect of trade liberalization on per capita income growth for 120 countries for the period 1970 to 1997. He used two types of trade openness measures. The first openness measure was estimated by using trade volumes which include different ratios of trade variables (exports, imports, exports plus imports and trade with developed countries) with GDP. Another measure based on trade restrictiveness estimated by calculating restrictions on foreign exchange on bilateral payments and current transactions. The results of the Generalize Method of Movement (GMM) estimates showed that the first group of openness, based on trade volumes were significant and positively related to per capita growth. However, for developing countries, openness based on trade restrictions was also significant and positively related to per capita growth. He, therefore, concluded that trade restrictions in developing countries may cause faster GDP growth.
Using the model of Sinha and Sinha (2000) which states that GDP growth has three components namely; trade growth, investment growth, and population growth, Siddiqui and Iqbal (2005) estimated the impact of trade liberalization on output growth for Pakistan. The volume of trade (import plus export) is used as a proxy of openness and for that matter the degree of liberalization. In their study, the estimated co-integration equations for the model showed that there is a long-run negative relationship between trade growth and GDP growth. However, when they separated the total trade volume in export and import, they found an insignificant positive relationship between GDP growth and export and import. Both models showed a positive and significant relationship between GDP growth and investment as well as GDP growth and population growth. The Granger Causality tests also showed an insignificant relationship between trade growth and GDP growth while investment growth and population growth were found to have a significant relationship with GDP growth.
Edward (1992) used a cross country data set to analyze the relations between trade openness (trade intervention and distortions) and GDP growth of 30 developing countries over the period 1970 to 1982. In his model, he used two basic sets of trade policy indicators, constructed by Leamer (1988). The first set refers to openness and measures of trade policy (tariff and Non- Tariff Barriers - NTB) which restrict imports. The second set measures trade intervention and captured the extent to which trade policy distorted trade. The results of the model, estimated by OLS, showed that all the four openness indicators were positively related to real per capita GDP growth, while trade intervention indexes were found to be significant and negatively associated with GDP growth. These studies support the hypothesis that countries with a more open trade regime have tended to grow faster, and a more distorted trade regime will tend to grow slower. Santos-Paulino (2002) examined the impact of trade liberalization on export growth for a sample of 22 developing economies between 1972 to 1998. He used a typical export growth function which postulates that export volume depends upon the real exchange rate and world income. Trade openness is measured in two ways. First by the ratio of export duties to total export, as an indicator of the degree of anti-export bias and second by a dummy variable of the timing of the introduction of trade liberalization measures. The results of the OLS estimate showed export duty significant with a negative sign and the dummy variable is also significant with a positive sign. Therefore it was concluded that exports grow faster in open economies.
Wacziarg (2001) investigated the links between trade policy and GDP growth in a panel of 57 countries from 1970 to 1989. His study employs a fully specified empirical model to evaluate the six channels through which trade policy might affect growth. He measured openness through an index which consisted of three trade policy variables, Tariff barrier, captured by share of import duties to total imports, Non-tariff barriers, captured by un-weighted coverage ratio for the pre-Uruguay Round period and a dummy variable (liberalization status). The fixed estimate OLS results showed that three-channel variables i.e., FDI inflows as a share of GDP, domestic investment rate, and macroeconomic policy, were significant. He, therefore, concluded that there is a positive relationship between trade openness and GDP growth.
Edwards (1998) used comparative data for 93 countries to analyze the robustness of the relationship between openness and total factor productivity (TFP) growth. He used nine indexes of trade policy to analyze the connection between trade policy and TFP growth for the period1980 to 1990. Among these nine indexes, three were related to openness, a higher value of which denotes a lower degree of policy intervention in international trade. The other six were related to trade distortions, for which higher values denote a greater departure from free trade. The results of OLS estimates found trade openness indexes significant with positive signs and trade distortion indexes were significant with negative signs. This relationship suggests that more open countries will tend to experience faster productivity growth than more protectionist countries. The important point of the study was that the coefficients were very small, up to 100th decimals points, while the value of R2 was also very low.
Harrison (1996) used a general production function to analyze the relationship between openness and GDP growth. He specified GDP as a function of capital stock, years of primary and secondary education, population, labor force, arable land, and technological changes. He used seven openness measures to test the statistical relationship between openness and GDP growth. The cross-section estimation results show only the black market rate significant with a negative sign. The country time-series panel result showed that three variables, tariff and non-tariff barriers with a positive sign, black market rate, and price distortion index used in dollar with a negative sign, were found significant. Estimation for Annual data shows two variables, tariff, and non-tariff barriers, and black market rate, significant with a negative sign. Population, labor force, and technology were also found to have positive and significant. He, therefore, concluded that the choice of the period for analysis, of the relationship between trade openness measures and GDP growth, is critical. Using data for 87 countries, Hakura and Jaumotte (1999) find that trade indeed serves as an important way for the international transfer of technology to developing countries. The authors show that intra-industry trade plays a more important role in technology transfer than inter-industry trade. Intra-industry trade is more pervasive among developed countries, and inter-industry is more prominent in trade between developed and developing countries. Developing countries will enjoy relatively less technology transfer from trade than developed countries. Rivera-Batiz (1996) describes a model depicting two identical economies operating under autarchy and then subsequently engaging in trade to establish the impacts of trade on technological innovation and productivity growth within the endogenous growth framework. In this framework, there is only one homogenous final good, which is an intermediate or capital goods. The assumption was that without trade, the two economies are producing capital goods which are differentiated from each other. When the two countries engage in trade, each has available the ideas of the other, represented by the stock of blueprints for the capital goods. The larger body of ideas and knowledge doubles the rate of innovation and results in productivity growth in both economies. Rivera-Batiz adds that the effects of trade on growth will depend very much on the extent to which the national innovation system can effectively use the new information and blueprints to generate new products. If the specialized human capital required to use the new ideas and blueprints is not available or is limited, the growth effects from trade in intermediate goods would not be substantial. Whatever the extent of the impact of the new knowledge on innovation, the model suggests a definite positive impact of trade on medium and long-term growth.
Ahmed, Y. and Anoruo, E. (2000) investigated the long-run relationship between GDP growth and openness for five Southeast Asian countries, namely, the Philippines, Indonesia, Malaysia, Singapore, and Thailand for the period 1960 to 1997. They used export plus import growth rate as a proxy of openness. The Johansen estimation results rejected the hypothesis that there is no cointegration between economic growth (GDP) and openness while the hypothesis that the error correction term is significant could not be rejected. This Vector Error Correction estimates showed bi-direction causality between economic growth and trade openness. Sinha D., Sinha T. (2000) analyzed the effects of the growth of trade openness and investment on the growth of GDP for 15 Asian countries from 1950 to 1992. They developed a model that specified GDP growth as a function of growth rates of openness (export plus import), domestic investment, and population. The Auto-Regressive Model (ARMA) results show that for China, Hong Kong, Iran, Iraq, Israel, Myanmar, Pakistan, and Singapore, the coefficient of the growth of openness is positive and significantly different from zero. For China, Hong Kong, Indonesia, Israel, Japan, Jordan, Philippines, Singapore, and South Korea, the coefficient of the growth of domestic investment is positive and significantly different from zero. In some cases, the coefficient of the growth of the population is negative but in all such cases, it is not significantly different from zero. Thus, they find support for the proposition that the growth rate of GDP is positively related to the growth rates of openness and domestic investment. However, the relationship between the growth rate of GDP and the growth rate of the population is not that clear cut.
Harrison (1991) also has pointed out that new growth or endogenous growth theorists do not predict that free trade will unambiguously raise economic growth. She adds that increased competition could, for example, discourage innovation by lowering expected profits. Grossman and Helpman (1991) also pointed out that one of the key inputs to a country's innovation system is human capital and the amount of human capital allocated to innovation is closely reflected in technological change in the economy. Trade could constrain innovation and growth if it tends to shift human capital from research and development activities to other sectors of the economy to meet the human capital needs of direct production activities. In countries with scarce skilled human capital, this would drive human capital away from research and development, reducing innovation and growth.
The situation described above is particularly the case when the country's major exports are human capital intensive. Grossman and Helpman concluded that in such countries, the indirect gain from trade is to encourage growth. Cantwell (1992) added that a country wishing to capture the benefits of new ideas generated by trade would need to develop its national innovation system defined as the network of institutions that support the initiation, modification, and diffusion of new technologies. The pre-condition for such an innovation system is an adequate pool of human capital and institutional capacity in the country. Porter (1990), in a wide-ranging study on innovation and competition, concluded that "competitive advantage emerges from pressure, challenge, and adversity, which are powerful motivations for change and innovation." He added that protection, in its various forms, insulates domestic firms from the pressure of international competition. Sherer (1986) has also noted that most observers cannot escape acknowledging the invigorating effect rivalry commonly has on industrial firm's research and development efforts. Rivera-Batiz (1995) presented a simple model showing the mechanisms through which trade generates innovation. He demonstrated that by augmenting the rivalry facing producers in the local market, trade could induce domestic producers to increase their Research & Development activities leading to greater innovation and raising domestic total factor productivity. The model presented in Rivera-Batiz's paper incorporates gains from trade-related to increased domestic productivity and economic growth associated with foreign competition. Studies of long-run growth also suggest that the invention and development of new goods and inputs constitute one of the major sources of economic growth. If trade stimulates competition leading to the creation of new inputs and products, long term growth will arise.
Trade Policy and Performance in African Countries
In Africa and other developing regions trade plays a quantitatively important role. Thus, a larger share of their income is spent on imports and a large share of their output is exported than is the case for developed countries with similar economic size. It is natural that the larger a country's GDP, the smaller its trade ratios. Most African countries have high ratios of external trade to GDP, which makes trade policy vital to the functioning and prospects of their economies. In Nigeria for example, the percentage contribution of foreign trade to GDP rose from 35 percent in 1960 to over 60 percent in the 1980s and over 75 percent in the 1990s. Other African countries depict similar characteristics. For example, in 1997, the trade to GDP ratio for Botswana was 88 percent, and that for Zambia was 66 percent. The comparative ratios for the developed countries were 28 percent for the UK, 11 percent for the United States, and 9 percent for Japan (World Development Indicators, 1998).
Before political independence, trade policies of most African countries were formulated as an integral part of colonial trade policies. They were aimed at promoting and regulating trade to serve the metropolitan country. These policies forged strong trade ties between the colonies and the metropolitan countries, effectively monopolizing the colonies' external trade. Special licenses had to be issued to obtain goods from outside the realm of the colonizers and usually, these could only be obtained where the goods in question were not available in the metropolitan country. One would say that African countries received their lessons in trade policy and practices from the metropolitan country, which in many countries have persisted over time. Trade policy in many African countries has been dominated by significant restrictions. African countries' protectionist trade policies were initially influenced by the perceived need to stimulate local industrial development, under the banner of import substitution and infant industry protection.
In many African countries, tariffs and quantitative restrictions have contributed to the most important form of trade restriction. A large proportion of imports into Africa was either subjected to outright prohibition or high tariffs or some sort of import ban or licensing mechanism. Usually, an industry can be protected from imports by the use of anyone of these measures. For example, applying a quantitative restriction or a tariff. Trade barriers in Africa were, however, excessive in that countries applied quantitative restrictions, tariffs, licensing, import bans, and foreign exchange regulations to control the flow of imports and exports. Protectionist policies were instituted to block imports into the countries, except those deemed as priorities by the government and obtainable through elaborate licensing arrangements. Ngy and Yeats (1998) computed average tariffs and non-tariff barriers (NTBs) imposed on imports from OECD countries by African countries and established that these were relatively high compared to a group of fastest-growing exporters.
As indicated in the table below, African countries maintained average tariffs of 26.8 percent compared to the 8.7 percent by the group of fastest-growing exporting countries. The comparable figure was 3.4 percent for the higher income non- OECD exporters. This trend is repeated concerning non-tariff barriers. The average coverage ratio of Non-Trade Barriers (NTBs) to tariffs for the Sub-Saharan African countries was 34 percent (for the low-income countries even higher at 40.6 percent) compared to 3.7 percent for the fastest growing exporters, and 4.0 for the non-OECD exporting countries.
EXPORTING COUNTRIES
OECD IMPORTS (1990-96)
1964-92 IMPORTS GROWTH RATE
TARIFF LEVELS OF EXPORTERS
NTB COVERAGE RATIO
All sub- African Africa
15146
5.41
26.8
34.1
Low income
11,433
5.21
28.6
40.6
Middle income
3,713
6.08
20.9
12.5
Fast growing exporters
271,157
16.77
8.7
3.7
Korea
44,839
24.61
11.1
2.6
Singapore
28,064
22.66
0.4
0.3
Taiwan
56,046
20.47
9.7
11.2
Hong Kong
26,178
13.65
0.0
0.5
Mexico
42,635
13.83
13.4
3.9
Bahrain
471
20.62
7.1
1.5
High income non- OECD
105364
18.18
3.4
4.0
Source: Ngy and Yeats (1998)
In many countries, exports were subjected to similar measures, with rules making it illegal to export "strategic" items or subjecting exports to high taxes. Special marketing agencies and boards were instituted to ensure compliance. In some countries, farmers or traders needed to obtain special permits to export surplus agricultural or "controlled" products. The most cited example of the adverse effects of high protection is exemplified by the tale of two neighbors, Ghana and Cote d'Ivoire. In Ghana, import prohibitions in the 1960s and 1970s encouraged inefficient high-cost production in manufacturing industries; controls and taxes on the main export crop cocoa discouraged its production and other crops were adversely affected by the unfavorable exchange rate. Cote d'Ivoire, on the other hand, pursued an open policy with minimum quantitative restrictions that encouraged the development of both primary and manufactured goods. As a result, it increased its share in world cocoa exports, developed new primary exports, and expanded manufacturing industries. Differences in policies applied may largely explain that between 1960 and 1978, per capita incomes, fell from $ 430 to $390 in Ghana, as compared to an increase from $ 540 to $840 in Cote d'Ivoire (Meier, 1996). This occurred, despite the two countries having similar resource endowments, and at the time of independence, Ghana has the advantage of a higher educational level.
The table below indicates the average tariffs on selected items in several African countries in 1990-96. The table reveals that tariffs on agricultural materials for all Sub-Saharan Africa averaged 23%, while fast-growing exporters had average tariff rates of 7.3 percent. Corresponding rates for crude fertilizers averaged 17%, compared to 4.7% for the fastest growing exporters. The average rates for all categories of goods, including final goods, were 26.7% for Sub-Saharan Africa and 10.8% for the fastest growing exporters. Ngy and Yeats (1998) point out that the high levels of tariffs and trade restrictions were instrumental in keeping the cost of important inputs beyond the reach of most local producers and exporters. The tariffs on production equipment and other goods and services that are often employed as key inputs in agriculture and manufacturing activity exaggerated the additional costs that potential exporters had to absorb to compete in foreign markets. The tariffs also inflated the associated costs of transport and utilities that also enter manufacturing and agriculture.
COUNTRY
AGRIC MATERIALS
CHEMICALS
ELECTRIC MACHINES
TRANSPORT EQUIPMENT'S
ALL ITEMS
ANGOLA
8.2
9.2
17.4
6.2
11.6
MALAWI
3.9
9.7
23.8
7.8
15.2
MOZAMBIQUE
16.2
10.3
11.5
16.2
15.6
TANZANIA
29.6
22.2
27.5
13.7
29.8
ZAMBIA
25.1
20.3
33.4
17.4
29.9
ZIMBABWE
1.4
3.7
15.4
7.8
10.1
COTE D'IVOIRE
9.3
20.7
25.4
17.4
23.3
SENEGAL
39.9
7.7
14.6
14
12.3
UGANDA
26.1
12.3
17.8
14.3
17.1
NIGERIA
25.0
22.2
31.4
22.7
32.8
GHANA
10.0
9.4
7.0
7.0
8.9
ALL OTHER SUB-SAHARAN AFRICA
23.6
19.8
28.5
18.9
26.7
Source: Ngy and Yeats (1998)
Oyejide (1997) also points out that the impact of the restrictive measures was to produce a large anti-export bias in the African countries. More specifically, restrictions on imports translate effectively into a tax on exports; by making import substitutes effectively more profitable, they increase the cost and reduce the availability of imported inputs which enter the production of exports, thus forcing exporters to use expensive inputs of doubtful quality. Import restrictions also made exporters face more appreciated exchange rates than would have been the case in their absence. Oyejide concludes that these elements combined to reduce the international competitiveness of the export sectors of the African countries-and subsequently reduced exports and GDP growth. Rodrik (1998) examined the role of trade and trade policy in achieving sustained long-term growth in African countries and concluded that high levels of trade restrictions have been an important obstacle to export performance and growth in Africa. He contends that the reduction of these restrictions can be expected to result in significantly improved trade performance in the region. To examine the differences in regional policies and impacts, Rodrik also makes a cross-comparison of trade policies in Sub-Saharan Africa with East Asia and Latin American countries using simple averages of tariff rates and coverage ratios of non-tariff measures (on intermediate and capital goods). Three major findings are emerging from the comparisons. Firstly that government-imposed trade barriers have generally been higher in Africa than East Asia, though the differences are not large. Secondly, until the early 1990s, trade barriers in Sub-Saharan Africa were comparable in magnitude to those prevailing in Latin America. Thirdly, the trade reforms that have occurred in Latin American economies – as well as in many former socialist economies in Eastern Europe -have left Sub-Saharan Africa as the only region in the world where substantial tariff and non-tariff barriers to trade are prevalent. It is thus worth examining the experiences of the African countries, especially the lower-income Sub- Saharan African countries in terms of export growth, in light of the restrictive trade policies. Many countries have witnessed cyclical declines and marginalization in export performance over the past three decades. Yeats (1997) points out that Africa's trade has grown at relatively low rates since the 1950s, with the result that today, the region's share in world trade stands at around 1%, down from more than 3 % in the mid-fifties. Indeed, African countries as a group have not fared well in trade, as seen from their exports, which have either stagnated or declined even in nominal terms. For example, between 1975 and 1984, African exports grew by an annual rate of 6.9 percent; this dropped to 2.9 percent during the period 1985-1989 (World Bank 1999). Exports increased slightly after 1994 but the expansion slowed again in 1998. Africa has also not fared well about its share of external trade compared to other developing regions in the world. In 1980, African countries accounted for close to 20 percent of all developing country exports. This fell to about 10 percent in 1990, before commencing a downward spiral for the next decade. In 1998, the share of African exports in total developing country exports was a dismal 6 percent and falling. The outlook for a rapid expansion in exports for the African countries is not encouraging. It needs to be pointed out that the figures being discussed are gross numbers incorporating South Africa and Nigeria. The position is worsened when these countries are excluded to include only Sub-Saharan Africa. The dismal performance in trade is closely reflected in developments in GDP growth. Africa's GDP growth averaged 0.8 % over the period 1965-1990. Growth in the fastest growing developing countries outside Africa averaged 5.8 %, while that for the rest of the developing world was 1.8% (Sachs and Warner 1999).
Furthermore, in the early 1960s, the GDP per capita in Sub-Saharan Africa was 60 percent of the average of the rest of the developing world. By 1990, this had fallen to 35 % and was much lower at the close of the millennium. Much of the decline occurred during the period 1980-94. The region recorded some modest gains after 1995 as reforms in several countries began to take hold. The marginalization of African countries in trade and GDP growth happened despite the trade preferences received under the OECD's Generalized System of Preferences (GSP) schemes and through the European Union's Lomé Convention, which extended low tariffs for African exports to the OECD area. Even lower tariffs have been extended to the least developed countries in the region. In summary, then, it can be seen that in Africa protectionist measures were instituted and sustained over time, to expand the local industry that may lead to increasing manufactured exports. This has ironically not been the case as the continent continued to be marginalized in trade and GDP growth.
CHAPTER THREE
Research Methodology
This chapter focuses on the conceptual framework of the model specified for the study. It will consist of five sections. Section one will provide the type and sources of data used for the study. The second section will focus on the specification of the model used for the study. Section three will discuss how the variables for the study will be defined and measured as well as the expected impact of the determinants. The fourth section will look at the estimation technique with emphasis on the autoregressive distributed lag (ARDL) model, otherwise called the Bounds Test which will be used to estimate the model specified for the study. Section five will deal with how the data was analyzed with an emphasis on time series analysis.
Data Type and Sources
The study will use annual time series data for the period 1986 – 2018 which will be obtained from published sources. The major sources of data will be World Bank's World Development Indicators, 2008 CD-ROM, IMF International Financial Statistics, 2006, African Development Indicators, WTO Trade Statistics. Other sources will include annual reports of Bank of Ghana, State of the Ghanaian Economy (various issues) by the Institute of Statistical, Social and Economic Research (ISSER). All estimations, as well as the various econometric tests, will be carried out using the Microfit 4.1 econometric software.
Model Specification
In this section, a growth model based on the aggregate production model approach to growth modeling will be specified for Ghana to estimate the impact of trade liberalization on GDP growth. The starting point of an empirical analysis of the growth model in any given economy is the growth model based on the aggregate production function given as:
Yt = f (A, K, L) ………………………………………….………………………. (1)
Where
Yt is real GDP at time t, A is the total factor productivity (TFP) while K and L are the usual capital and labor inputs, respectively.
Here, A captures the total factor productivity of growth in output not accounted for by an increase in capital and labor. According to endogenous growth theory, A is endogenously determined by economic factors.
Therefore, in Ghana and for that matter in this study, it is assumed that
A = g (OPENNESS, POPGR, INFL, FDI) ……………………………........... (2)
Where OPENNESS measures the extent of openness of the economy measured as a ratio of total trade (sum of exports and imports) to GDP. It is used as a measurement of liberalization; POPGR is the annual change in the population of the country; INFL is Inflation, a reflection of macroeconomic instability, and FDI is a foreign direct investment as a ratio to GDP.
Substituting equation (3) into equation (2) will yield:
GDPt = h (OPENNESSt, POPGRt, INFLt, FDIt, Kt, Lt) ………………........... (3)
However, data on the active employed labor force are not readily available (Ramirez, 2006), so many empirical studies (e.g. Li and Liu, 2005; Vamvakidis, 2002; Pattillo et al., 2002) use population as a proxy for labor. Hence, labor, Lt is dropped from the model.
Therefore, equation (4) becomes
GDPt = h (OPENNESSt, POPGRt, INFLt, FDIt, Kt,)……………………......... (4)
Equation (5) can be expressed as
GDPt = β0 +β1OPENNESSt +β2POPGRt+β3INFLt+β4FDIt + β5Kt +μt............ (5)
Where μt is the error term. All the other variables have already been defined.
From equation (6), the specific model for the real GDP growth for the Ghanaian economy in log-linear form is given as:
lnGDPt = β0 + β1 lnOPENNESST + β2 lnPOPGRt + β3 lnINFLt + β4 lnFDIt +
β5 lnKt + μt ..................................................................................................... (6)
Where the βi represent the elasticity coefficients
Equation (6) above shows the long-run equilibrium relationship.
The choice of the log-linear model was because of the following reasons
Firstly, to find the percentage change in the dependent variable resulting from percentage changes in the independent variable. Thus, the study will seek to find the responsiveness of a change in GDP growth to changes in openness, population growth, inflation, FDI, and capital (that is, elasticities of the variables), hence the need to use the log-linear model.
Secondly, while the values for some of the variables such as inflation, GDP growth were small others such as gross domestic fixed capital formation (a proxy for capital), population, FDI was very large (in millions). There was, therefore, the need to use the log form to bring the values for all the variables to the same unit or level.
Lastly, the use of log transformation is necessary because it reduces the scale of the variables from a tenfold to a twofold, thus reducing the possibility of heteroscedasticity in the model (Gujarati, 1995)
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