Domar Growth Model free essay sample

According to Thrall (2000), tariff levels in highly developed nations have skimmed down dramatically, and now average approximately 4 percent. Tariff levels in developing nations of the world have also been reduced, although they still remain relatively high, averaging 20 percent in the low-and middle-income countries. Non-tariff barriers to trade, such as quotas, licenses and technical specifications, are also being gradually dismantled, but rather more slowly than tariffs. Regional Trade Agreements (Arts) have also become very fashionable in the form of Free Trade Areas and Customs Unions. The WTFO lists 76 that have been established or modified since 1948. The major ones are the European Union (ELI); the North American Free Trade Area (NONFAT); Mercury covering Argentina, Brazil, Paraguay, Uruguay and Chile; APES, covering countries in the Asia and Pacific region; SEAN covering South-East Asian countries, and SACS, covering countries in southern Africa. The liberalizing of trade has led to a massive expansion in the growth of world trade relative to world output. While world output (or GAP) has expanded fivefold, the volume of world trade has grown 16 times at an average compound rate of Just over 7 percent per annum. In some individual countries, notably in South-East Asia, the growth tot exports has exceeded ten percent per annum. Exports have tended to grow fastest in countries with more liberal trade regimes, and these countries have experienced the fastest growth of GAP (Thrall, 2000). Foreign trade can be defined as commercial transactions (in goods and/or services) across international frontiers or boundaries. Foreign trade plays a vital role in estimating economic and social attributes of countries around the world. The workings of an economy in terms of growth rate and per-capita income have been based on the domestic production and consumption activities and in conjunction with foreign transactions of goods and services. Further, the role of foreign trade in economic development is considerable and the relationship between openness and economic growth has long been a subject of much interest and controversy in international trade literature. The classical and neo-classical economists attached so much importance to foreign trade in a nations development that they regarded it as an engine of growth. Over the past several decades, the economies of the world have become greatly connected through international trade and globalization. Foreign trade has been identified as the oldest and most important part of a countrys external economic relationships. It plays a vital and central role in the development of a modern global economy. Its impact on the growth and development of countries has increased considerably over the years and has significantly contributed to the advancement of the world economy. The impact of foreign trade on a countrys economy is not only limited to the quantitative gains, but also structural change in the economy and facilitating of international capital inflows. Trade enhances the efficient production of goods and services through allocation of resources to countries that have comparative advantage in their production. Foreign trade has been identified as an instrument and driver of economic growth (Franken and Roomer, 1999). It has been stated theoretically and proven empirically that economic openness contributes to the level of the economy (Errors and Denizen (201 1); Shaky (201 1); Chuddar et al (2010)). This is because in a competitive environment, prices get lower and the products become diversified through which consumer surplus emerges. Gains from specialization and efficiency are also further advantages of economic openness. Hence, it is quite reasonable that economies generally desire to be economically open. Of the various objectives of foreign trade, the promotion of economic growth and stability holds more weight. Various researchers have, in their various research works, delved into studying the numerous advantages and gains obtainable from trade between economies. As a result, there has therefore been an increasing interest in the study of foreign trade and its benefits particularly to developing countries. However, (recent) empirical investigations have not been able to show how healthy or otherwise, vastly (or scarcely) opened boarders are to economic growth. Actual gains from trade rather than gains accrued to vastly or scarcely open boarders are most often, the major points of discourse in most research. To this end, this research work concerns itself with examining how porous the Nigerian economy should be towards foreign trade. How exactly wide and receptive should the economy accommodate foreign trade in the quest for sustained long run economic growth? This study focuses extensively on the trade pattern of Nigeria over the years with more attention on the various trade policies or programs that and been adopted over the years. Relevant trade theories ranging trot classical theories to contemporary trade theories shall be highlighted. The Real Gross Domestic Product (Real GAP) shall be used as the indicator for the economic growth of Nigeria. The study time frame shall be restricted to fall between 1980 and 2011. The relevant questions in this research are: What has been the pattern of international trade in Nigeria? Has trade openness in Nigeria stimulated economic growth? To what extent should the economy be open to foreign trade in the quest for sustainable long run growth and development? Therefore, the main objectives of this paper are to: (1) examine the pattern of international trade in Nigeria. 2) determine if indeed, trade openness stimulates economic growth in Nigeria and, (3) determine the extent to which the economy should be open to foreign trade in the quest for sustainable long run growth and development. Congregation analysis is adopted for this study to test for the long run relationship between trade openness and economic growth in Nigeria. Individual variable relationship between the various trade openness indicators and economic growth variable (Real GAP) will be established and actual functional relationships will be determined using the LOS estimation method. The Augmented Dickey-Fuller unit root test for stationary will also be conducted for the variables of interest. Secondary data would be used in this study. The relevant data to be used would be sourced from the Central Bank of Insignias statistical reports, annual reports and statement of accounts for the years under review. The remaining part of the paper is structured as follows: in Section 2 we present a brief review of related literature alongside relevant trade and growth theories while Section 3 provides some stylized facts about the subject matter. Section 4 is on the Research Methodology and Empirical Result. In Section 5, we conclude the research work. 2. Review of Related Literature and Theories. Openness refers to the degree of dependence of an economy on international trade and financial flows. Trade openness on the other hand measures the international competitiveness of a country in the global marked. Thus, we may talk of trade openness and financial openness. Trade openness is often measured by the ratio of import to GAP or alternatively, the ratio of trade to GAP. It is now generally accepted that increase openness with respect to both trade and capital flows will be beneficial to a country. Increased openness facilitates greater integration into global markets. Integration and globalization are beneficial to developing countries although there are also some potential risks (aloha and Rakish, 2002). Trade openness is interpreted to include import and export taxes, as well as explicit non tariff distortions of trade or in varying degrees of broadness to cover such matters as exchange-rate policies, domestic taxes and subsides, competition and other regulatory policies, education policies, the nature of the legal system, the form of government, and the general nature of institution and culture (Baldwin, 2002). One of the policy measures of the Structural Adjustment Programmer (SAP) adopted by Nigeria in 1986 is Trade Openness. This meaner the dismantling of trade and exchange control domestically. Trade liberalizing has been found to perform the role of engine of growth, especially via high real productivity export (Baden, 1993). He argued that with export, a nation can take advantage tot division tot labor and procure desired goods and services from abroad, at considerable savings in terms of inputs of productive resources, thereby helping to increase the efficiency of the export industry. Export Roth sets up a circle of growth, so that once a country is on the growth path, it maintains this momentum, of competitive position in world trade and performs continually better relative to other countries. The doctrine that trade enhances welfare and growth has a long and distinguished ancestry dating back to Adam Smith (1723-90). In his famous book, and inquiry into nature and causes of the wealth of nations (1776), Smith stressed the importance of trade as a vent for surplus production and as a meaner of widening the market thereby improving the division of labor and the level of productivity. He asserts that between whatever places foreign trade is carried on, all of them derive two distinct benefits from it. It carries the surplus part of the produce of their land and labor for which there is no demand among them, and brings back in return something else for which there is a demand. It gives value to their superfluities, by exchanging them for something else, which may satisfy part of their wants and increase their satisfaction. By meaner of it, the narrowness of the labor market does not hinder the division of labor in any particular branch of art or manufacture from being carried to the highest perfection. By opening a more extensive market for whatever part of the produce of their labor may exceed the home consumption, it encourages them to improve its productive powers and to augment its annual produce to the utmost, and thereby to increase the real revenue of wealth and society (Thrall, 2000). We may summarize the absolute advantage trade theory of Adam Smith, thus, countries should specialize in and export those commodities in which they had an absolute advantage and should import those commodities in which the trading partner had an absolute advantage. That is to say, each country should export those commodities it produced more efficiently because the absolute labor required per unit was less than that of the prospective trading partners. (Applecart and Field, 1998) In the 19th century, the Smithsonian trade theory generated a lot of arguments. This made David Richard (1772-1823) to develop the theory of comparative advantage and showed rigorously in his principles of political economy and taxation (1817) that on the assumptions of perfect competition and the full employment of resources, countries can reap welfare gains by specializing in the production of those goods with the lowest opportunity veer domestic demand, provided that the international rate of exchange between commodities lies between the domestic opportunity cost ratios. These are essentially static gains that arise from the reallocation of resources from one sector to another as increased specialization, based on comparative advantage, takes place. These are the trade creation gains that arise within customs to trade are removed between members, but the gains are once-for-all. Once the tariff barriers have been removed and no further reallocation takes place, the static gains are exhausted. The static ins from trade stem from the basic fact that countries are differently endowed with resources and because of this the opportunity cost of producing products varies from country to country. The law of comparative advantage states that countries will benefit if they specialize in the production of those goods for which the opportunity cost is low and exchange those goods for other goods, the opportunity cost of which is higher. That is to say, the static gains trot trade are measured by the resource gains to be obtained by exporting to obtain imports more cheaply in terms of resources given up, compared to producing the goods oneself. In other words, the static gains from trade are measured by the excess cost of import substitution, by what is saved for not producing the imported good domestically. The resource gains can then be used in a variety of ways including increased domestic consumption of both goods (Thrall, 2000). Baldwin (2003) has demonstrated persuasively that countries with few trade restrictions achieve more rapid economic growth than countries with more restrictive policies. As poverty will be reduced more quickly through faster growth, poor countries could use the trade liberalizing as a policy LOL. Trade liberalizing reduces relative price distortions and allows those activities with a comparative advantage to expand and consequently foster economic growth. Poor countries tend to engage in labor-intensive activities due to an overabundance of available labor. Thus the removal of trade barriers in these countries promotes intensive economic activity and provides employment and income to many impoverished people. On the other hand, the pursuit of trade-restrictive policies by labor endowed poor countries distorts relative prices in favor of capital-intensive activities. The removal of trade barriers could lead to a decline in the value of assets of protected industries and therefore to the loss of Jobs in those industries. This implies that trade liberalizing has distributional effects as industries adjust to liberalized trade policies. Economist Ann Harridans 1991 paper makes a synthesis of previous empirical studies between openness and the rate of GAP growth, comparing the results from cross- section and panel estimations while controlling for country effects. Harrison concluded that on the whole, correlations across openness measures seem to be positively associated with GAP growth the more open the economy, the higher the growth rate, or the more protected the local economy, the slower the growth in income. 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. Franken and Aroma (1999) and Irwin ND Torero (2002) in their separate and independent studies also suggested that countries that are more open to trade tends to experience higher growth rates and per-capital income than closed economy. Klaxon and Rodriguez Clare (1997) used general equilibrium model to establish that the greater number of intermediate input combination results in productivity gain and higher output, despite using the same capital labor input which exhibit the economics increasing international trade return to scale. Nigeria is basically an open economy with international transactions constituting a significant proportion of her aggregate output. To a large extent, Insignias economic development depends on the prospects of her export trade with other nations. Trade provides both foreign exchange earnings and market stimulus for accelerated economic growth. Openness to trade may generate significant gains that enhance economic transformation. This meaner that, there will be diffusion of knowledge and innovation amongst other open economies tot the world . Trade openness has been hailed for its beneficial effects on productivity, the adoption and use of better technology and investment promotion which are channels for stimulating economic growth. Over the years, Nigeria has identified deeper trade integration as a meaner to foster economic growth and to alleviate poverty. 2. Theoretical Review 2. 1. 1 TRADE THEORIES: Trade as Engine of Growth. The origins of trade can be traced to the absolute and comparative advantage as well as Heckler Olin theories Momma, 2001). The theory of absolute advantage was formulated by Adam Smith in his famous book title Inquiry into the nature and the wealth of Nations 1776. The theory emanated due to the dem ise of mercantilism. Smith argued that with free trade each nation could specialize in the production of hose commodities in which it could produce more efficiently than other nations and import those commodities it could not produce efficiently. According to him, the international specialization of factors in production would result in increase in the world output. Thus this specialization makes goods available to all nations. 2. 1. 2 Comparative Advantage Theory This theory was propounded David Richard. The theory assumed the existence of two countries, two commodities and one factors of production. To him a country export the commodity whose comparative advantage lower and import commodity whose imperative cost is higher. The theory also assumed that the level of technology is fixed for both nations and that trade is balanced and rolls out the flow of money between nations. However, the theory is based on the labor theory of values which states that the price of the values of a commodity is equal to the labor time going into the production process. Labor is used in a fixed proportion in the production of all commodities. But the assumptions underlying is quite unrealistic because labor can be subdivided into skilled, semiskilled and unskilled labor and there are other factors of production. Despite the limitations, comparative cost advantage cannot be discarded because its application is relevant in explaining the concept of opportunity cost in the modern theory of trade. . 1. 3 Heckler-Olin Trade Theory The theory focuses on the differences in relative factor endowments and factor prices between nations on the assumption of equal technology and tastes. The Model was based on two main propositions; namely; a country will specialize in the production and export of commodity whose production requires intensive use of abundant resources. Secondly, countrie s differ in factor endowment. Some countries are capital intensive while some are labor intensive. He identified the different in pre-trade product prices between nations as the immediate basis of trade, the prices depends on production possibility curve (supply side) as well as the taste and preference (demand side). But the production possibility curve depends on factor endowment and technology. To him, a nation should produce and export a product for which abundant resources is used be it capital or labor. The model suggests t developing countries are labor abundant and therefore they should concentrate in he production of primary product such as agricultural product and they should import capital intensive product I. . Manufactured goods from the developed countries. The model also assumes two countries, two commodities and two factors and that two factors inputs labor and capital are homogeneous. The production function is assumed to exhibit constant return to scale. However, the theory is not free from criticism and this because factors inputs are not identical in quality an d cannot be measured in homogeneous units. Also factor endowment differs in quality and variety. Relative factor prices reflect differences in relative factor endowment- supply therefore outweigh demand in the determination of factor prices. Despite this criticism, trade increases the total world output. All countries gain from trade and it also enables countries to secure capital and consumption of goods from the rest of the world. 2. 2 THEORIES OF ECONOMIC GROWTH Economic growth is best defined as a long term expansion of productive potential of the economy. Trend growth is the smooth path of long run national output I. E. It requires a long run series of macroeconomic data which could be twenty years or ore. The trend of growth could be expanded by raising capital investment spending as a share of national income as well as the size of capital inputs and labor supply, labor force and the technological advancement. There are different schools of thought that have discussed the causes of growth and development and they are discussed below. 2. 2. 1 Neo-classical Growth Theory. This was first propounded by Robert Solos over 40 years ago. The model believes that a sustained increase in capital investments increased the growth rate only temporarily, because the ratio of capital to labor goes up. The marginal product of additional units is assumed to decline and thus an economy eventually moves back to a long term growth-path with the real GAP growing at the same rate as the growth of the workforce plus factor to reflect improving productivity. Neo-classical economists who subscribe to the Solos model believes that to raise an economy long term trend rate of growth requires an increase in labor supply and also a higher level of productivity of labor and capital. Differences in the rate of technological change between countries are said to explain much of the variation in growth rates. The neo-classical model treats productivity improvements as an exogenous variable which meaner that productivity improvements are assumed to be independent of the amount of capital investment. 2. 2. 2 Endogenous Growth Theory. To them, they believe that improvements in productivity can be attributed directly to a faster pace of innovation and external investment in human capital. They stress the need for government and private sector institutions to encourage innovation and provide incentives tort individual and business to be inventive . There is also central ole of the accumulation of knowledge as a determinant of growth I. E. Knowledge industries such as telecommunication, electronics, software or biotechnology are becoming increasingly important in developed countries. The proponent of endogenous growth theory believes that there are positive externalities to be exploited from the development of a high value added knowledge economy which is able to developed and maintain a competitive advantage in fact growth within the global economy. They are of the opinion that the rate of technological progress should not be taken as a constant in a growth model- government policies can rearmament raise a country growth rate if they lead to move intense competition in markets and help to stimulate product and process innovation. That they are increasing returns to scale from new capital investment and also private sector investment is a key source of technical progress and that investment in human capital is an essential ingredient of long term growth. . 2. 3 Harrow Dammar Growth Model Harrow-Dammar opined that economic growth is achieved when more investment leads to more growth. They theory is based on linear production function with output given by capital stock (K) tines a constant. Investment according to the theory generates income and also augments the productive capacity of the economy by increasing the capital stock. In as much as there is net investment, real income and output continue to expend. And, for full employment equilibrium level of income and output to be maintained, both real income and output should expand at the same rate with the productive capacity of the capital stock. The theory maintained that for the economy to maintain a full employment, in the long run, net investment must increase continuously as well as growth in the real income at a rate sufficient enough to maintain full capacity use of a growing stock of capital. This implies that a net addition to the capital stock in the form of new investment will go a long way to increase the flow of national income. From the theory, the national savings ratio is assumed to be a fixed proportions of national output and that total investment is determined by the level of total savings I. E. S = SYS which must be equal to net investment, l. The net investment which is I = AK = KAY because K has a direct relationship to total national income. And, therefore SYS = KAY which simply meaner AY/ Y is growth rate of GAP that is determined by the net national savings ratio, s and the national capital output, K in the absence of government, the growth rate of national income will be positively related to the saving ratio I. . The more an economy is able to save and invest out of a given GAP, the greater the growth of GAP and which will be inversely related to capital output ratio. The basis of the theory is that for an economy to grow, it should be able to save and invest a certain proportion of their GAP. The basis for foreign trade rests on the fact that nations of the world do differ in heir resource end owment, preferences, technology, scale of production and capacity for growth and development. Countries engage in trade with one another because of these major differences and foreign trade has opened up avenues for nations to exchange and consume goods and services which they do not produce. Differences in natural endowment present a case where countries can only consume what they nave the capacity to produce, but trade enables them to consume what other countries produce. Therefore countries engage in trade in order to enjoy variety of goods and services and improve their peoples standard of living. . Some Stylized Facts. Nigeria is Sub-Sahara Africans second largest economy, with nominal 2006 GAP of $Bonn (at APP) behind South Africans $Bonn. It has also been one of Africans fastest growing economies, outpacing South Africa, Kenya, Ghana and most of its neighbors with a CARR of 7% over the past 10 years. However, its growth has been more erratic due to the high reliance on natural resources (see further UNDO, Human Development Report 2007). Despite the fast pace of growth and the strong resource endowment, Nigeria has so far not increased its GAP per capita beyond that of its mailer and resource-poor neighbors. Its GAP per capita is below that of Cameroon, Ivory Coast, Kenya, and it is only 12% that of South Africa. Poverty and the rural nature of the Nigerian economy put pressure on financial services institution to innovate and to reach out to poor customers. Insignias economy is heavily reliant on the oil and gas sector. It makes up more than 40% of the GAP (Natural Resources and Industry), and accounts for virtually 100% of exports and 80% of budgetary revenues for the government. Nigeria is the worlds 12th largest producer of oil, mainly applying the US. Next to natural resources the most important sector is agriculture, accounting for approximately 35% of GAP. A large portion of this is subsistence farming with declining productivity. This composition of GAP is quite unlike that of its neighbors, due to the importance of natural resources in the country. The natural resources sector is one of the drivers of sophistication in the financial services industry. While rising oil and gas prices have had a strong positive effect on GAP, exports and government revenues over time, it has however, not been Insignias only river of growth. For instance, in 2007 political unrest in the Delta region affected oil production, but strong growth in the non-oil sector meant that overall GAP still grew by 5. 8%. The non-oil sector has grown at a 7% CARR over the past 10 years. This growth is expected to remain robust, due to good performances in certain sectors of the economy, particularly in communications, wholesale and retail trade, and construction; the financial sector will play a key part in facilitating further growth in the economy. Hence, as a result of the large volume of oil export in Nigeria, it is clear hat foreign trade is essential in ensuring foreign earnings which should enrich the nations foreign exchange/national reserves with a view to exploring such surpluses into growth related activities for the country. 4. Research Methodology and Empirical Result This section basically concerns itself with the methodology of the research as well as presenting the result of econometric estimation and gives explanation of various findings. The importance of this section lies in its quantitative and empirical content within which the purpose of this study would be Justified. Also of importance in this heaper is the overall findings and validation of hypothesis tested. This section is therefore divided into two namely: model specification and general discussion of results obtained from the various unit root test, LOS estimation as well as the congregation analysis. 4. Model Specification Following the production attention theory which snow now the level tot a count productivity depends on foreign direct investments (FED), trade openness (OPEN), exchange rates (EXERT) and government expenditure (JEEP), we specify our model showing how the interplay of these chosen variables actually affect the economic growth of Nigeria. The mathematical model will be based on the methodology adopted by Jude and Pop-Silages (2008) for the countries Romania and Karakas; Mohammed and Giovanni (2005) for 42 developing countries. However for this study, we make some slight adjustments to the adopted methodology to suit the scope within which this study covers. The model used for this study has been so chosen because of its relevance to the Nigerian environment and availability of data. The dependent variable chosen for this study as proxy for economic growth is the real gross domestic product, written as RIGID. The explanatory variables are: Exchange ate, Foreign Direct Investment, Government Expenditure and Trade Openness. Mathematically, the functional relationship between variables of interest is as written below: RIGID = f(VPN, EXERT, FED, JEEP) ? Writing the above equation explicitly in an econometric sense, we have: RIGID = With a view to lingering equation (it), we apply the Logarithmic function thus: Where , and are regression parameters and is the standard error term, which is a random variable and has well defined probabilistic properties. Also, OPEN = Degree of openness, determined by the sum of total imports and exports, divided by total output I. E. EXERT = Real exchange rate in Nigeria FED = Foreign Direct Investments from abroad to the country JEEP = Government Expenditure in the country. The signs on the variables are based on the priori expectations from theory, which is the direction of the relationship between the respective independent variables and the explained or dependent variable. The Real GAP variable is included to capture the growth and activity of the economy. How well an economy is performing, how rich an economy is, as well as how the condition of general well-being in an economy is re all captured in the RIGID variable. The degree of openness, OPEN, measured as the ratio of the sum of total export and total imports to the GAP. According to Allege and Sousaphone (2013), African economies can be regarded as largely open in view of OPEN at an average of about 104. 85% over the period of study and 82. 26 per cent in 2007 only. Open economies are preferred by market seeking and efficiency seeking investors since there are fewer trade re