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Article Excerpt
Abstract
A foreign trade model is estimated for two South East Asian countries, selected because they represent two extremes as far as the current account balance is concerned--Malaysia, deficit, Singapore, surplus. The specification highlights, (a) the simultaneous interdependence of exports and import flows--a result of what Krugman [1995] denotes as the slicing up of the production process--and, (b) the impact of investment on imports as a result of productivity shocks on the current account. The estimation results point to the instability of the market for foreign exchange. Using an intertemporal framework, a methodology to derive the external long run equilibrium is applied to the estimated model. The implied constraint on domestic growth turns out to be mild. (JEL C53, F41)
Introduction
This paper intends to analyze some new aspects of the specification of international trade equations empirically and derive from them conditions on the long-run sustainability of the current account, and the implied constraints on domestic growth. For that purpose, econometric estimations of foreign trade equations for two South East Asian countries--Malaysia and Singapore--are presented. The two cases have been selected on the grounds of data availability and because they represent two extremes as far as the current account is concerned--deficit for Malaysia and surplus for Singapore. The Engel-Granger OLS estimation procedure to estimate long-run equations with trending variables has been implemented, given the moderate available sample size in the sample period.
The specification of the equations departs from the conventional model, which can explain several empirical facts. Specifically, two aspects are underscored: (a) the simultaneous interdependence of import and export flows; and (b) the direct impact of investment on imports. The first can be understood as a result of what Krugman [1995] denotes as the slicing up of the production function among several countries (specially noticeable in the case of multinational firms), and can partly explain the rise in world trade in recent years. In this framework, imports become an input in the production of exports, so that one can expect a direct dependency of imports on exports (a demand side effect) and of exports on imports (a supply side effect). The direct impact of investment on imports, as a result of a productivity shock, for example, is also highlighted in the specification of the equations. This is a rational effect in an intertemporal setting where a positive productivity shock leads to higher current investme nt, financed by borrowing from abroad. There is a current account deficit and higher future income that will allow increased consumption and the repayment of the debt incurred in the first period. The productivity shock, in turn, may be well explained as the result of a transfer of technology, brought about by openness to trade and foreign investment (Feenstra et al. [1992]; Grossman et al. [1995]; Markusen [1995]; Pack et al. [1997]; Sjoholm [1997]). The specification of trade equations put forward in this paper can explain some empirical findings that conventional models cannot. Since a large share of imports is made up of inputs for the production of export goods, a depreciation reduces both imports and exports, having only a mild improvement impact on the trade balance. A reduction in foreign investment, on the contrary, directly improves the current account by reducing imports. It is argued, nevertheless, that a moderate slowing down in the domestic growth rate is enough to achieve a sustainable current account equilibrium.
The paper analyzes, in a second step, the long-run sustainability of the current account, and the implied constraints on domestic growth (in the vein of Thirlwall [1979], and McCombie and Thirlwall (1994]). The analysis is performed with increasing complexity and applied to the estimated models for both countries. The full intertemporal approach that imposes long-run equilibrium of the current account is derived and implemented to derive the constraints on domestic growth. On the basis of this analysis, it is concluded that foreign restrictions to domestic growth do not seem to be strong for these countries. Some implications for exchange rate policy derived from the estimated equations are also discussed (specifically, from the possible instability of the foreign exchange market).
The structure of the paper is as follows. Section two discusses and presents the specification of the model and related questions on the exchange rate. The third section presents the econometric results, based on long-run estimations of cointegrated equations. Section four is devoted to an analysis of the foreign constraint on domestic growth, which is conducted by means of the intertemporal solvency constraint. The fifth section presents the main results, discusses briefly their main implications, and suggests further research. A final appendix provides details of the statistical data.
Some Preliminary Background
The authors start with the non-standard features of the trade model specification, that is, the direct dependency of imports on investment, and the simultaneity among exports and imports. Imports can depend directly on investment through a positive productivity shock. This will make investment more attractive and will induce firms to increase investment in new capital goods. If the origin of the productivity shock is a technology transfer, the new capital goods that embody the new technology will not be available in the domestic economy, and therefore will have to be imported. The productivity shock, in turn, may have come about by a knowledge transfer, driven by openness to trade and foreign investment. These channels for the knowledge transfer, and therefore for the positive productivity shock, have been emphasized in the literature by several authors (Feenstra et al. [1992]; Grossman et al. [1995]; Markusen [1995]; Pack et al. [1997]; Sjoholm [1997]). From an intertemporal perspective, a similar result can be explained as the outcome of optimizing behavior. Increased productivity allows increased production and income in the future....
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