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Economics, Management, and Financial Markets Volume 7(1), 2012, pp. 67–80, ISSN 1842-3191

EXPORT AND ECONOMIC GROWTH IN TURKEY: COINTEGRATION AND CAUSALITY ANALYSIS

FATIH MANGIR

fmangir@selcuk.edu.tr Selçuk University

ABSTRACT. This paper investigates the empirical evidence on the link between export and economic growth by using quarterly time series data for the Turkish economy over the period 2002–2011. The study applies Johensen and Juselius co- integration and Granger causality test. Further, the co-integration analysis established that GDP and export were found to be co-integrated and suggesting an existence of long-run relationship. In the short-run, we find evidence of short-run bidirectional causality to support export-led growth by using Granger causality tests in Turkey for the period between 2002 and 2011. In the long run, our result shows existence of long run unidirectional causality between economic growth and export in the long-run. JEL Classification: D92, F43, N1, O41 Keywords: trade and growth, export-led growth (ELP) strategy, cointegration and Granger-Causality Test

1. Introduction Recently, a central role of foreign trade policy for economic growth has been gained a great attention of economic researches for developing and developed countries. Foreign trade has been accepted as an increasingly large role in the growth of world economy since A. Smith’s traditional economic theory, and an even larger role in developing and emerging economies. Trade leads to growth by specialization in production. And specialization of country’s abundant production factor also enable country to trade more costly goods from the rest of the world and boost welfare. Integration to the world economies also helps country to change its technological capacity through more advanced countries technology transfer. Also by increasing trade also restricts monopoly power in country and holds prices down for

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consumer benefits. However, it is clear that benefiting trade policy for economic growth highly depends on the macroeconomic environment, the design and selecting of trade policies and world economic outlook. Trade policy adopted by a country also strongly influences the direction, trend and growth of a country. Trade policy can be import substitution (IS) meaning protective trade policy or export-oriented with free trade policy. Nurkse (1953), Lewis (1956), Clark (1957), Tinbergen (1958), Hirschman (1959), Rostow (1960), Lebenstein (1963), R. Rodan (1964), Singer (1966), Myrdal (1968), Prebisch (1969) all recommended an inward looking development path with a leading governmental role in growth process (Hirway, 1998:3). According to these economists, developing countries should expand the role of the industrial sector in the domestic market to substitute for imports by adopting IS strategy. The main target of IS strategy is to support infant industries. Infant industry protection policy is a policy that allows an im- mature industry to expand production by temporarily providing some pro- tection such as import tariffs and tries to make the industry internationally competitive by picking up dynamic economies of scale (Kimura, 2002:4). These countries mostly performed import substitution strategy that encourages industrial growth within a nation in order to reduce imports of manufactures, save foreign exchange, provide jobs, and reduce foreign dependency. However, the import substitution has several numbers of criticisms (Jayanthakumaran, 2000: 14): - Under import substitution strategy, countries experienced both low volume

of exports and high dependence on foreign intermediate goods due to the exchange rate appreciation. This would mean that the trade balance will get worse due to the lower export. This in turn leads the country (that applies IS strategy) to borrow money in order to finance the trade deficit.

- A real possibility of government failures and the costs associated with resulting from the attitudes of bureaucrats, influence of powerful pressure groups and substituting private interests on the expense of public interests by politicians and employees needs to be addressed.

- Prevailing foreign exchange controls may tend to promote the use of more inappropriate capital-intensive techniques of production.

- Exchange controls and protections together may result in a vast increase in rent-seeking activities.

- A forgoing view is that infant industries in developing countries have had a tendency never to grow up.

- Import-substitution policy creates biases in the incentive structure and lowers the growth of potential exports in the long term. This necessitates the need of export-oriented policy over time.

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Therefore, for the failures of the IS strategy listed above, counties trans- formed to the structure of trade policies into export-led growth (ELP) stra- tegy. ELG strategy recommends countries to prepare economic structure for export oriented production. ELP model is an economic policy aiming to develop industries that a country has a comparative advantage in the export goods. According to mainstream literature, the potential benefits associated with the ELG strategy with respect to IS is as follows (Felipe, 2010: 263): (i) the domestic resource cost of earning a unit of foreign exchange tends to be less than the domestic resource cost of saving a unit of foreign exchange; (ii) as the ELG rests on exogenous world demand, a developing economy can overcome diseconomies of small size. And in general, technology-economic factors (e.g., minimum efficient size of plant, increasing returns to scale, indivisibilities in the production process) imply a superiority of development through export promotion; (iii) for being exposed to world competition, firms in the country can increase X-efficiency (i.e., the forces that intensify motivation that result in lower cost curves for the firm); (iv) a protrade strategy may attract foreign direct investment; (v) ELG contributes more than does IS to employment creation and im- provement in the distribution of income; and (vi) a higher rate of growth of exports is associated with a high growth. Transformation from import substitution strategy to export lead trade in- creases the efficiency and advantages in production by revaluation and transfer of technology. However, export-led growth has also some problem and drawbacks affected world economies. The main problem of export-led growth is pro- posed by a standard Keynesian theory. According to Keynes, demand determined equilibrium, and maintains that the level of economic activity adjusts to equal the level of aggregate demand. Within a Keynesian frame- work, export-led policy suffers from an inherent fallacy of composition whereby one country’s attempts to boost domestic aggregate demand by increasing exports results in a reduction of domestic aggregate demand in the country it is exporting to (Palley, 2003: 178). Second weakness of ELG is that the relation between economic growth and development of domestic markets is blocked. The more dependent foreign demand leads less developed countries to lose their rivalries situation and so makes countries fragile to instabilities of world economy. The ELG strategy is also blamed for mainly contributed to the Asian financial crisis, 1997–1998. During the crisis countries such as Korea, Thailand, Indonesia and the Philippines very much affected (Thesen, 2007: 58).

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In spite of many weakness of ELG stated above, there is a possibility of causal affect between export and growth and foreign trade may play a central role in a country’s economic growth and development. The main aim of this study is to examine the nexus of exports and economic growth in Turkey. We identify the 1972–1979 period as the deepening of the industrial- ization strategy based on import substitution (ISI) (Boratav and Yeldan, 2002: 4). As in many other countries that adopted ISI, Turkey faced with a serious balance of payment crisis in the late 1970s as a result of rapid increase in the cost of oil imports and increasing import needs during the process of capital deepening. The balance of payment problems slowed down economic growth, and caused even a decline in GDP in 1979 and 1980. The period of ISI was ended by another military coup in 1980 (Taymaz and Yılmaz, 2007:3). Turkey in the 1980s changed structural reforms of its economy into export-lead development strategy. Trade reforms and export promotion successfully served three purposes in the adjustment strategy of the govern- ment in the 1980s: to alleviate balance of payments constraints, to restore the confidence of the international financial institutions and external creditors, and to stimulate efficient economic growth (Öniş and Webb, 92: 1). With the Jan. 24 decision in 1980, Turkey economic policy makers aim to stabilize domestic prices, to finance economic growth with the foreign capital, and to adopt market-based economic model. The main parameters of these decisions are the export subsidies and exchange rates depreciation to make export sector more competitive. Öniş (2009) characterize this period as an export boom and summarize with the rise of export-oriented capital; broadening of the neoliberal coalition in the 1990s to include small and medium sized export-oriented capital (Anatolian tigers); beginnings of globalization of Turkish big business es- pecially with the Customs Union. The most important step towards increasing foreign exchange earnings was the devaluation of Turkish lira approximately 50% against the US dollar. Moreover, to close the price scissors between official and “black market” prices, the Central Bank began to set the US dollar rate daily. To promote exports, supports such as tax rebates, duty-free allowances and low-interest credits were granted to exporting firms. The total amount of subsidies reached up to 30% of the total value of exports in mid 1980’s (Kızılca and Özcan, 2008: 139). However, import liberalization process in the late 1980s led to an increase in the imports of consumer goods. In 1990, further import liberalization measures were introduced during a period of real exchange appreciation, with the result that there was a noticeable trade and current account deficit (Utkulu and Durmuş, 2004: 249).

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Graph 1 shows the data covering 2002 and 2011 years belonging to the exports and GDP of Turkey which are obtained from Turkish Statistical Institute and are displayed in Graph 1. That export and GDP run parallel in some period can be seen from the graph. Therefore, the purpose of the present study is to find the direction of causality between exports and GDP. To that and, we have carried out a Granger Causality Test on the data displayed in Graph 1 and present and discuss the results below.

Graph 1. 2002–2011 GDP and Export (Thousands of ¨, Quarterly data)

2. Literature Review The determiner role of export in economic growth has been argued in many theories. For classical economic theory, trade blocks such as tariffs and quotas should be removed and liberal policies of trade should be implemented. Because, international trade leads countries to obtain economic gain from division of labor and specialization and it plays an important role in economic growth. The neo-classical theory, also favor trade activities and economic growth gain of countries by introducing demand side of international trade, the relationship between factor allocation, income distribution and international trade. The new or endogenous growth theory which is a view of the economy that incorporates important point, technology can be transferred internationally through trade and imitated by late-coming countries. The imitation of tech- nology has two opposing effects on the incentives of innovating firms in developed countries. Besides core economic theories, the nexus between export and economic growth have been popular subjects both theoretically and empirically in international economics area. Several studies have been detected this relation by time series and cross section analysis.

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While some of the studies tested the export-growth relation supports the export-led growth hypothesis, the others doesn’t conclude the validity of the hypothesis. Michaely (1977), Balassa (1978), Krueger (1978), Chenery (1979), Tyler (1981), Kavoussi (1984), Ram (1985), Chow (1987), Fosu (1990), Salvatore and Hatcher (1991), Crospo and Wörz (2003) are the studies about this subject were the results support the export growth hypo- thesis (Anwer and Sampath, 1997: 3). Jung and Marshall (1985) Darrat (1986), Xu (1996) Colombatto (1990), Ahmad and Kwan (1991) Afxentiou and Serletis (1991), Bahmani-Oskooee et al. (1991), Ahmed et al. (2000) are studies that all reject the export-led growth hypothesis (Anwer and Sam- path, 1997:3). Studies analyzing the relationship between exports and economic growth in Turkey found also different result. Rodrik (1995) studies four countries (Korea, Taiwan, Chile and Turkey) and presents very briefly Granger causality tests between the share of investment in GDP and the share of exports plus imports in GDP. No causality could be detected for either direction in Turkey. Yigidim and Kose (1997) studied variables for the years 1980–1996 and found no causality between export and growth but when they use variables in logarithmic form of first differences has identified unidirectional causality. Ozmen and Furtun (1997) tested the export-led growth for the years of 1970–1995 in Turkey by using time series and concluded the long-term co-integration between the two variables is significant. Ozmen et al. (1999) used the quarterly data during the period 1983:1–1997:2. They have tested the causality issue between export and output by applying the standard Granger (1969) causality method. The results show unidirectional causality from export to output under the consideration period. Simsek (2003) found in his study bi-directional causality running from growth to export but rejected export-led growth hypothesis. Alici and Ucal (2003) employed Toda and Yamamoto (1995) causality technique to test the hypothesis using quarterly data 1987:1–2002:4. The results indicate uni-directional causality running from export growth to output growth. Demirhan (2005) analyzed the relationship between export and growth for the years of 1987–2004 and he detected the result of the long-term relationship. Taban and Aktar (2005) concluded that the existence of uni-directional causality between two variables for the years of 1980–2003 but no sign of long-term relation. Demirhan and Akcay (2005) made the study of the relationship between export and growth. They found granger causality running from economic growth to export growth. Karagöl and Serel (2005) found bi-directional causality relation running from GDP to export for the period of 1955–2002. Halıcıoglu (2007) seeks to validity of the export-led growth hypothesis using quarterly data from 1980 to 2005 and found suggest unidirectional causation from exports to industrial production. Taban and Aktar (2008) found that the existence of

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bi-directional causality between two variables for the years of 1980–2007. Aktas (2009) found no granger causality from export and growth for the period of 1996–2006. Ozturk and Acaravci (2010) support the export-led growth hypothesis for Turkey and that Granger causal flow is unidirectional from real exports to real GDP by using quarterly data from 1989 to 2006.

3. Methodology, Model and Data Set

In this study, the validity of export-led growth in Turkey was examined by using Johansen cointegration analysis. Initially, both the ADF and Philips Perron unit root test were employed to examine stationary whether the variables present a unit root. Later, the Johansen co-integration method was applied to check if there is co-integrating relationships exist among export and growth. This study uses quarterly series of Real Gross Domestic Product (Y), and Exports (X) and in Turkey for the period of 2002Q1–2011Q3 drawn from the database of Turkish Republic Central Bank and State Planning Organization. Export and GDP data in a logarithm form were transformed into TL by using average dollar sale exchange rate. Based on the data collected from 2002 to 2011, this paper explores the short-term and long-term relationship between export (LX) and economic growth (LY) by applying co-integration analysis and Granger causality test. 3.1 Unit Root Test

It has become a standard practice in econometric analysis to examine the time series properties of the variables in the model. We use the Augmented Dickey Fuller (1979) and Philips-Perron (1988) test for the existence of unit roots and identify the order of integration for each variable. The results of the ADF and PP tests for stationary properties of the variables are presented in Table 1. Table 1 Results of the ADF and PP unit roots tests

Augmented Dicky-Fuller Test (ADF test)

Philips-Perron Test (PP test)

Level Form First Difference Level Form First

Difference LY -1,5005 -3,76* -1,73 -3,80* LX -1.5456 -6,55* -0,815 -6,66* Significant Level Critical Values %1 -3,60 -3,61 -2,63 -2,63 %5 -2,94 -2,94 -1,95 -1,95 %10 -2,60 -2,60 -1,61 -1,61 Note: *Denotes for 5% significance level, **Denotes for 1% significance level.

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The Table 1 above shows that two variables were not stationary in levels. This can be seen by comparing the observed values (in absolute terms) of the test statistics with the critical values (also in absolute terms) of the test statistics at the 1%, 5% and 10% level of significance. The results of the first differenced variables show that the ADF and PP test statistics for two variables are greater than critical values at 1%, 5%, 10% levels and the two variables are stationary after differenced, suggest- ing that two variables are integrated of order I(1). 3.2. Co-integration Test In this study, the maximum likelihood estimation method of Johansen and Juselius (1990) is employed to test for cointegration. The maximum like- lihood procedure of Johansen (1988) and Johansen and Juselius (1990) method to cointegrated models provides an efficient procedure for the estimation of cointegrated systems. The main advantage of the Johansen Maximum Likelihood (ML) method is that it enables one to determine the number of existing cointegrating (i.e. long-run) relationships among the variables in hand (Utkulu, 1997: 43). VAR and the corresponding VECM model is defined as follows:

Xt = c + x1Xt-1 +x2Xt-2 + ……xpXt-p + +εt (1) where Χ = Real GDP (Y) and export (X). And also, c is a constant term (3x1 in our case), p = nxn matrices of autoregressive coefficients for i = 1, 2…p, it must be presented a reparametrisation of equation (1) in order to distinguish between stationary by linear combinations and differencing. Thus the system equation in (1) can be rewritten as follows:

∆ Χt = c + Γ1∆ Χt-1 +Γ 2 ∆ Χt-2 + ……Γp-1 ∆ Χt-p+1 + ΠΧt-p+ε (2) where Γi = -(I – π1–….πi ) (i = 1…, p-1) and Π = -(I – π 1 - … - π p) (3) We will first examine the Π matrix to detect the existence of cointegrating relations among the X variables. If rank (Π) = r < n, then there are matrices β and α of dimension nxr such that H0: Π = α β’ and there are r co- integrating relations among the elements of βXt is accepted as a matrix of cointegration vectors and provides the property that elements in β’Xt are stationary even though Xt is non-stationary. The Johansen maximum likelihood approach Johansen (1988) and Johansen and Juselius (1990) is used to test the cointegration in the second step if the results proves cointegration the either unidirectional or bidi- rectional then Granger causality must exist, at least in the I (0) variables (Karagol, et al., 2006:369). The Johansen co-integration results based on

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Johansen maximum likelihood approach employing both maximum eigen- value and trace statistic for VAR=1 can be seen in table-2. We note the results of cointegration analysis obtained by the estimation (a) with the lag length k=1. We recognize a single cointegrating vector for the system by rejecting reject the null of no cointegration (r=0) but not the null of at most one cointegrating vector (r=1) according to the maximal eigenvalue (λ max) and trace eigenvalue (λ trace) statistics. The eigenvectors presented in Table 2 are normalized by LY. Table 2 Johansen and Juselius Cointegration Test

Series: LY, LX r Trace

Statistics Critical Value 5%

Max-Eigen Statistic

Critical Value

5%

Result

r=0 23.89480(2) 20.26184 18.23742(2) 11.22480 r≤1 9.164546 9.686700 9.164546 9.686700 Cointegrated

Normalized cointegration equation: LY = 0.966364 LX ** Denotes for 5% significance level. The optimum lag-lengths are indicated within parentheses and they are determined by the Schwarz criterion. The aim of an impulse response function is to identify the effect of a one-time shock to one of the innovations on current and future values of the endogenous variables (Root and Lien, 2003). A shock to the i-th variable not only directly affects the i-th variable but is also transmitted to all of the other endogenous variables through the dynamic (lag) structure of the VAR. Figure 1 Impulse response functions one standard deviation shock in LY

Figure 1 depicts the impulse responses of GDP to an export shock. It is clear from figure above that the response of GDP is positive for 4 years

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however from the rest of the years this shock negatively affects LY and the effect of the shock is permanent. Figure 2 Impulse response functions one standard deviation shock in LX

Figure 2 shows that the effects of one standard deviation shock given to the GNP (LY) on export (LX). We can say that when one standard deviation shock is given to the LY, this shock affect on LX four year negatively however from the five year this shock positively affects LX and the effect of the shock is permanent. 3.3 Granger Causality Tests If the variables are cointegrated, a VECM should be estimated rather than a VAR as in a standard Granger causality test Granger (1988). Therefore, we estimate a VECM for the Granger causality test because we found a cointegration relationship between export and GDP.

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(5) where LX and LY refer to export and GDP respectively. As we showed the series to be cointegrated, there must be either uni- directional or bidirectional Granger causality, since at least one of the error correction terms (ECT) is significantly nonzero by the definition of co- integration. First, by testing for all d yi equals 0 in equation (4) or for all Wzi equals 0 in equation (5), we evaluate Granger weak causality. This can be implemented using a Standard Wald test. Masih and Masih (1996) and Asafu-Adjaye (2000) interpreted the weak Granger causality as ‘short run’

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causality in the sense that the dependent variable responds only to short-term shocks to the stochastic environment. The other possible causality is added the ECT in equation (4) and (5). The coefficients on the ECT represent how fast deviations from the long run equilibrium are eliminated following changes in each variable. In order to test Granger causality, we will investigate whether the two sources of causation are jointly significant. This can be done by testing the joint hypo- theses that all d yi and θ1(ECT) are jointly zero in equation (4) or all Wzi and θ2(ECT) are jointly zero (0) in equation (5). This is referred to as a strong Granger causality test. The joint test indicates which variable(s) bear the burden of short run adjustment to reestablish long run equilibrium, following a shock to the system Asafu-Adjaye (2000). Table 3 Granger Causality Tests

Source of Causation (Independent Variable) Dependent Variable Short Run-Causality Long Run-Causality LY LX ECT/LY ECT/LX LY 4.64** ----------------- 1.27** LX 3.25**

The appropriate lag lengths are chosen using Schwartz’s Information Criteria (AIC). * Denotes for 5% significance level. ** Denotes for 1% significance level. As can be seen from the Table 3, F statistics, which are applied the lagged coefficients of ΔX and ΔY are all jointly significant at the 5% and 1% levels, respectively. We conclude that there is a uni-directional short run causal relationship between the variables from export to economic growth. We cannot reject the null hypotheses that the coefficients on the ECTs and the interaction terms are jointly zero in LY equation while we can reject the null hypotheses that the coefficient on the ECT and the interaction terms are jointly zero in the LX equation. The coefficients of the ECTs in the LX equation are significant at the 1% level. So we found bi-directional long- run causality between export and GDP using Wald test. In summary, Granger causality test results indicate that there is a unidirectional causality relationship between export growth and real GDP growth in short run and but bidirectional in the long run in Turkey for the period 2002–2011.

4. Result This paper examined the causal relationship between export and GDP for Turkey over the period 2002–2011 using a bivariate model of GDP and

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export. To test Granger causality, we employed a VECM instead of a VAR model because we found strong evidence that the variables are cointe- grated and we wanted to study the short run relationship as well as the long run dynamics. Our test results unveil bidirectional long term causality and unidirectional short term causality between export and growth of Turkey. When we compare our results with those of studies on Turkey mentioned in literature review, we have obtained similar results with Özmen et al., (1999), Alıcı and Ucal (2003), Öztürk and Acaravcı (2010) have showed unidirectional causality from export to growth. On the other hand, the other studies conducted by Doğanlar and Fisunoğlu (1999), and Taban and Aktar (2008), which just found bidirectional causality in the long-run.

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