TESTING IMPORT-LED GROWTH HYPOTHESIS IN NORTH CYPRUS: AN EMPIRICAL INVESTIGATION FROM COINTEGRATION AND CAUSALITY TESTS

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1 Ι 27 TESTING IMPORT-LED GROWTH HYPOTHESIS IN NORTH CYPRUS: AN EMPIRICAL INVESTIGATION FROM COINTEGRATION AND CAUSALITY TESTS Assoc. Prof. Salih KATIRCIOGLU Easern Medierranean Universiy Deparmen of Banking and Finance Lec. Elif KATIRCIOĞLU Easern Medierranean Universiy Deparmen of Business Adminisraion Absrac: The presen paper empirically ess he Impor-led Growh Hypohesis (ILGH) in Norh Cyprus, which is sae is no recognized by counries oher han is mainland, Turkey and suffers from he Cyprus problem for more han 0 years. Coinegraion es resuls reveal ha long-run equilibrium relaionship exiss beween impors of goods and services and real income growh in his small island sae; real income converge o is long erm equilibrium level by as high as 99%. However, causaliy ess in he presen sudy do no validae he exisence of he ILGH in Norhern Cyprus. Keywords: Impor-led Growh, Economic Growh, Coinegraion, Causaliy, Norh Cyprus Öze: Mevcu çalışma, Türkiye Cumhuriyei nden başka bir ülke arafından anınmayan ve 0 yıldan fazla bir süredir, Kıbrıs sorunun çözümsüzlüğünden dolayı ekonomik sancıları yaşayan, Kuzey Kıbrıs Türk Cumhuriyei nde, İhala a Dayalı Büyüme Hipoezi ni es emeyi hedeflemekedir. Mevcu çalışmada uygulanan eşbüünleme esleri, ihala ile reel gelir arasında uzun dönemli bir denge ilişkisinin olduğunu oraya koymakadır; ihala'ın kakısı ile reel gelir uzun dönem dengesine 99% luk hızla yaklaşmakadır. Faka, Granger nedensellik esleri, Kuzey Kıbrıs için ihalaa dayalı büyüme hipoezinin varlığını onaylamamakadır. Anahar Kelimeler: İhalaa Dayalı Büyüme, Ekonomik Büyüme, Eşbüünleme, Nedensellik, Kuzey Kıbrıs

2 28 Ι Tesing Impor Led- Growh Hypohesis in Norh Cyprus 1. INTRODUCTION Inernaional rade is a major source of foreign exchange for all he counries in he earh bu i is more imporan for smaller counries. Especially, small islands have more dependency on inernaional rade since heir economies are based on only a few secors (Kaircioglu, 2010a). For example, according o Kuznes (1966), as he counry ges smaller, is dependency on inernaional rade would increase. On he oher hand, alhough many economiss agree ha small counries have similar advanages and disadvanages when compared o he larger ones, here are differences in he origin of hese disadvanages (Kaircioglu, 2010a). Among common disadvanages are foreign rade dependency, vulnerabiliy, high populaion growh, limied labor, low labor efficiency, diseconomies of scale, low GDP (Gross Domesic Produc), high dependency on impors of inermediae and consumpion goods, and producion of only a few basic goods/services (Kaircioglu, 2010a). Since he economy of small islands based on a few secors, heir expor capaciy is quie limied; herefore, he island economies heavily depend on impors of goods and services from abroad. There have been many sudies ha invesigae he ILGH in he lieraure (see Deme, 2002 among he ohers). In addiion o cross-counry applicaions, ime series and causaliy analyses examining he concep of he ILGH were also pracically considered in addiion o he Expor-led growh hypohesis. This is mainly due o he fac ha impors are vial for raw maerials, as well as inermediae goods and capial goods which are used in he producion process of expored goods and services. This mechanism simulaes economic growh for many counries. The presen sudy empirically ess he ILGH in a small island, Turkish Republic of Norhern Cyprus (TRNC), which is no a recognized sae (only recognized by is mainland, Turkey). This sudy is imporan in he sense ha i, as a firs ime, considers he relaionship beween impors and real income growh in his small island sae which suffers from foreign rade relaionships wih he oher counries due o he poliical reasons. This realiy made he Turkish Cyprio economy heavily depending on impors from abroad. The presen sudy also employs he laes economeric echniques of he Johansen coinegraion es and Causaliy es under block exogeneiy wald ype es o forecas his relaionship. The TRNC was esablished in 1983 in Cyprus and is no recognized by counries oher han he mainland Turkey. Norh Cyprus has a populaion over 265,000 and 10,537 US$ per capia income (SPO, 2011). Inernaional ourism and he emergence of higher educaion secor are wo major sources of foreign exchange o his small island since TRNC does no have considerable foreign rade relaionship wih counries oher han Turkey due o he poliical non-recogniion (Kaircioglu, 2010a). Therefore, resuls of his sudy will be imporan for policy makers in such a impordepended island economy. The paper proceeds as follows. Secion 2 defines he heoreical seing of he presen sudy. Secion 3 defines daa and mehodology. Secion provides resuls and discussions and he paper concludes wih Secion 5.

3 Salih & Elif Kaırcıoğlu Ι THEORETICAL SETTING There are huge amoun of sudies sudying he deerminans of economics growh especially wihin he growh accouning framework (see Kaircioglu, 2010a). There are sudies ha modeled impor-led growh equaions where impors were assumed o be imporan deerminan of real income. On he oher hand, exchange raes are considered as a very imporan variable affecing inernaional rade (boh expors and impors) and is relaionship wih real income (See Kaircioglu, 2009; 2010a; 2010b). Thus, he following relaionship can be esablished in his sudy: y = f (M, RER ) (1) where real income (y) is a funcion of impors (M) and real exchange raes (RER). This relaionship in equaion (1) can hen be expressed in logarihmic form o capure he growh impac of independen variables (Kaircioglu, 2010a; 2010b): ln y 0 1 ln M 2 ln RER (2) where a period, lny is he naural log of real income; lnm is he naural log of impors variable; lnrer is he naural log of real exchange raes; and is he error disurbance. The expeced sign of coefficen for M is posiive in equaion (2) implying ha growh in impors and real exchange raes are likely o exer posiive impac on real income growh; herefore, equaion (2) can be expressed as imporgrowh model. As also Kaircioglu (2010a and 2010b) sugges real income in equaion (2) may no immediaely adjus o is long erm equilibrium level following a change in any of heir deerminans; herefore, he speed of adjusmen beween he shor erm and he long erm levels of real income as dependen variable can be capured by esimaing he following error correcion model: ln y (3) n n n 1 ln y j 2 ln M j 3 RER j 1 i 1 i 0 i 0 0 ln u

4 30 Ι Tesing Impor Led- Growh Hypohesis in Norh Cyprus where represens change in y, M, and RER variables and -1 is he one period lagged error correcion erm (ECT), which is esimaed from equaion (2). The ECT in equaion (3) shows how fas he disequilibrium beween he shor-run and he long-run values of dependen variable is eliminaed each period (Kaircioglu, 2010a; 2010b). The expeced sign of ECT is negaive (See Gujarai, 2003). 3. DATA AND METHODOLOGY Daa used in he presen paper are annual figures ha cover he period and variables are real gross domesic produc (GDP), real impors of goods and services, and real exchange raes in he TRNC. Daa are aken from Sae Planning Organizaion of he TRNC (SPO, 2011) and variables are all a 2005 consan USD prices. Prior o esimaing he models as defined in he previous secion, he Phillips- Perron (PP) 9 Uni Roo Tes was employed o es he inegraion level and he possible co-inegraion among he variables (Dickey and Fuller 1981; Phillips and Perron 1988). The PP procedures, which compue a residual variance ha is robus o auo-correlaion, are applied o es for uni roos as an alernaive o ADF uni roo es (Kaircioglu, 2009). To invesigae long-run relaionship in equaion (2), he Johansen coinegraion es has been employed in his sudy. Cheung and Lai (1993) menion ha he race es is more robus han he maximum eigen value es for coinegraion. The Johansen race es aemps o deermine he number of coinegraing vecors among variables. There should be a leas one co-inegraing vecor for a possible coinegraion. The Johansen (1988) and Johansen and Juselius (1990) approach allows he esimaing of all possible co inegraing vecors beween he se of variables and i is he mos reliable es o avoid he problems which sems from Engel and Granger (1987) procedure 10. This procedure can be expressed in he following VAR model: X 1 X 1... K X K e (for =1, T) () Where X, X -1,, X -K are vecors of curren and lagged values of P variables which are I(1) in he model; 1,., K are marices of coefficiens wih (PXP) dimensions; is an inercep vecor 11 ; and e is a vecor of random errors. The number of lagged values, in pracice, is deermined in such a way ha error erms are 9 PP approach allows for he presence of unknown forms of auocorrelaion wih a srucural break in he ime series and condiional heeroscedasiciy in he error erm. 10 See Kremers e al. (1992) and Gonzalo (199) for he commens abou disadvanages of Engel and Granger (1987) procedure compared wih Johansen and Juselius (1990) coinegraion echnique. 11 μ is a vecor of I(0) variables which represen dummy variables as well. This ensures ha errors e are whie noise.

5 no significanly auo-correlaed. Adding X -1,, X -K and 1 X -2,, K-1 X -K o boh sides and rearrange erm he VAR model will be in he following form 12 : X Salih & Elif Kaırcıoğlu Ι 31 1 X 1... K 1 X K 1 X K e (5) where i =-(I- i -.- i ); (i=1, 2,, K-1); =-(I ) and I is he ideniy marix. The rank of he marix of coefficien, gives he number of long-run relaionships beween he variables of he sysem. Three possible cases are saed by Johansen and Juselius (1990): i) If he ranks equal P[r( ) = P] meaning ha has full rank, hen any linear combinaion of I(1) series is saionary. ii) If he rank equals zero (r( ) = 0, i.e. is a null marix), hen here is no co inegraion relaionship. Alhough a long-run relaionship seems o be unlikely, a shor-run relaionship may be idenified by he firs differences. iii) If he rank is beween zero and P (0 < r( ) < P), hen here are marices α and β wih (pxr) dimension, so ha i is possible o represen = α β. Marix β is called he co inegraing marix whereas marix α is referred o as he adjusmen marix or he feedback marix. Marix β has he propery o ransform β X ino a saionary process even ough X is no in he equilibrium relaionship. The rank of is he number of co inegraing relaionship(s) (i.e. r) which is deermined by esing wheher is Eigen values (λ i ) are saisically differen from zero. Johansen (1988) and Johansen and Juselius (1990) propose ha using he Eigen values of ordered from he larges o he smalles is for compuaion of race saisics 13.. The race saisic (λ race ) is compued by Asseery he following formula 1 : race i T Ln(1 ), i = r+1,, n-1 (6) and he hypoheses are : H 0 : r = 0 H 1 : r 1 H 0 : r 1 H 1 : r 2 H 0 : r 2 H 1 : r 3 In he case of coinegraion in equaion (2), Granger causaliy ess should be carried ou using block exogeneiy Wald ess (ha use Chi-square ess, χ 2 ) under vecor error correcion mechanism o also es for he ILGH in he presen sudy. 12 This form of he equaion is also called vecor error correcion. 13 Asympoic criical values are obained from Oserwald-Lenum (1992). 1 A he beginning of he procedure, we es he null hypohesis ha here are no co inegraing vecors. If i can be rejeced, he alernaive hypohesis (i.e. r 1,, r n) are o be esed sequenially. If r=0 canno be rejeced in he firs place, hen here is no co inegraing relaionship beween he variables, and he procedure sops

6 32 Ι Tesing Impor Led- Growh Hypohesis in Norh Cyprus Having saisically significan χ 2 raio as Wald saisic would mee condiions o have long-run causaion from independen variable o dependen variable. Causaliy ess using block exogeneiy approach are carried ou under he vecor error correcion model (VECM) in he case of co-inegraion By VECM, he shorrun deviaions of series from heir long-run equilibrium pah are capured by including an error correcion erm (Jenkins and Kaircioglu, 2010). Therefore, he VECM can be specified in equaion (6): q L ln Y 22 L X ECT 1 ln Y (6) p 1 21 ln Where P ij p 1 q ij L ijn L ij L n 1 Q ij n 1 ijn L 1 In equaions (6), denoes he difference operaor and L denoes he lag operaor where (L) lny = lny -1. ECT -1 in equaion (6) is he lagged error correcion erm derived from he long-run co-inegraion model. Finally, μ is serially independen random errors wih mean zero and finie covariance marix.. RESULTS AND DISCUSSIONS The PP uni roo es resuls sugges ha real GDP, impors, and real exchange raes in Norh Cyprus are non-saionary a heir levels bu become saionary a heir firs differences; herefore, GDP, M, and RER in he presen sudy are said o be inegraed of order one, I (1) 15. Table 1. Johansen Coinegraion Trace Tes Hypohesi zed Trace 5 Percen 1 Percen No. of CE(s) Saisic Criical Value Criical Value None * A mos A mos Noe: Lag lengh is 1 in his esimaion. 15 Uni roo ables and resuls can be gahered from he auhors of he sudy upon he reques.

7 Salih & Elif Kaırcıoğlu Ι 33 Since he variables of he sudy are inegraed of order one, here is sill a possibiliy ha here migh be coinegraion relaionship in equaion (2). Johansen coinegraion es has been employed wih his respec. As can be seen from Table 1, he null hypohesis of no coinegraing vecor is rejeced and is alernaive of a leas one coinegraing vecor in equaion (2) is acceped according o race es. This confirms coinegraion (long erm) relaionship in equaion (2) using lag one ha sugges long erm impor growh model in he case of Norh Cyprus. Having long erm relaionship in equaion (2) he level equaion is needed o forecas long erm coefficiens in equaion (2). The esimaes of level relaionship impor-growh model can be given by: Table 2. Impor-Growh Relaionship in Equaion (2): Normalized coinegraing coefficiens (sandard error in parenheses) LGDP LIMPORT LRER ( ) ( ) Impors have inelasic bu posiive and saisically significan elasiciy coefficien ( ) for real income growh in Norhern Cyprus. RER is also posiive bu no saisically significan. Table 2 sugges ha one percen variaion in impors leads o percen variaion in real income in he long erm and in he same direcion. In he nex sage, he error correcion model associaed wih he above level relaionship should be esimaed. This given in Table 3:

8 3 Ι Tesing Impor Led- Growh Hypohesis in Norh Cyprus Table 3. Error Correcion Model in Equaion (3) Error Correcion: D(LGDP) CoinEq [ ] D(LGDP(-1)) [ ] R-squared F-saisic Log likelihood Akaike AIC Schwarz SC Mean dependen S.D. dependen D(LIMPORT(-1)) [-0.710] D(LRER(-1)) [ ] C [ ] DTREND [ ] Resuls in Table 3 show ha error correcion erm is very high (0.99), saisically significan and has expeced sign (-). This shows ha real income in equaion (3) converge a a very high level (99.0%) o is long-erm equilibrium level; lag lengh in Table 3 is one. On he oher hand, he lagged coefficiens in he shor erm are no saisically significan where inercep and rend dummy are saisically significan. Finally, F raio of he model in Table 3 is no again saisically significan. Bu, since raio of error correcion erm is saisically significan, we conclude ha real income converge o is long erm equilibrium level very high in impor growh model. Table. Granger Causaliy Tess under Block Exogeneiy Approach Dependen variable: D(LGDP) Excluded Chi-sq df Prob. D(LIMPOR T) D(LRER) All Dependen variable: D(LIMPORT)

9 Salih & Elif Kaırcıoğlu Ι 35 Excluded Chi-sq df Prob. D(LGDP) D(LRER) All Dependen variable: D(LRER) Excluded Chi-sq df Prob. D(LGDP) D(LIMPOR T) All Finally, he direcion of causaliy can be now searched wihin he Block Exogeneiy Wald ess under vecor error correcion framework. Granger causaliy es resuls are given in Table wih his respec. Granger causaliy ess have been run under pairwise basis. Table shows ha none of he χ 2 saisics are saisically significan. This siuaion does no idenify any long erm causaliy beween real income, impors, and real exchange raes in he case of Norh Cyprus; herefore, his is o conclude ha he ILGH hypohesis canno be inferred in he Turkish Cyprio economy using Johansen mehodology. This finding is similiar o he finding of Kaircioglu (2010a) where he same conclusion was reached for Norh Cyprus by employing bounds ess and condiional error correcion models.. CONCLUSION This paper empirically esed he impor-led growh hypohesis in he case of Norh Cyprus by esimaing long erm equilibrium relaionship and causaliy beween impors and real income growh. Resuls of he presen sudy reveal ha alhough long erm equilibrium relaionship exiss beween impors and economic growh in his small island, impors have posiive long erm coefficien for real income, Granger causaliy ess did no confirm he ILGH in Norh Cyprus. The sudy couldn idenify any causaliy beween impors and real income in he long erm period of he Turkish Cyprio economy. These resuls are similiar o he findings of Kaircioglu (2010a). Bu, i is imporan o noe ha impor growh model is valid in he long erm for Norh Cyprus and real income converge o is long erm equilibrium level very high (99%) by he conribuion of impors. Furhermore, impors have posiive and saisically significan long erm elasiciy coefficien for

10 36 Ι Tesing Impor Led- Growh Hypohesis in Norh Cyprus real income, which is Alhough he ILGH couldn be confirmed for Norh Cyprus, resuls of he error correcion model shows ha impors are sill vial for he Turkish Cyprio economy. REFERENCES Cheung, Y. and Lai, K. (1993), Finie-sample sizes of Johansen s likelihood raio ess for co-inegraion, Oxford Bullein of Economics and Saisics, Augus, Deme, M. (2002), An examinaion of he rade-led growh hypohesis in Nigeria: A co-inegraion, causaliy, and impulse response analysis, The Journal of Developing Areas, 36/1, Dickey, D. and Fuller, W. A. (1981), Likelihood raio saisics for auoregressive ime series wih a uni roo, Economerica, 9, Engle, R. F. and Granger, C. W. J. (1987), Co-inegraion and error correcion: Represenaion, esimaion and esing, Economerica, 55, Gonzalo, J. (199), Five alernaive mehods of esimaing long-run equilibrium relaionships, Journal of Economerics, 60, Gujarai, D. N. (2003), Basic Economerics, h Ediion, Mc Graw-Hill Inernaional. Jenkins, H. P. and Kaircioglu, S. (2010), The Bounds Tes Approach for Coinegraion and Causaliy beween Financial Developmen, Inernaional Trade and Economic Growh: The Case of Cyprus, Applied Economics, 2 (13): Johansen, S. (1988), Saisical analysis of co-inegraing vecors, Journal of Economic Dynamics and Conrol, 12, Johansen, S. and Juselius, K. (1990), Maximum likelihood esimaion and inference on co-inegraion wih applicaion o he demand for money, Oxford Bullein of Economics and Saisics, 52, Kaircioglu, S. (2009), Revisiing he Tourism-led-growh Hypohesis for Turkey Using he Bounds Tes and Johansen Approach for Coinegraion, Tourism Managemen, 30/1, Kaircioglu, S. (2010a), Trade and Growh in a Non-Recognized Small Island Sae: Evidence from he Turkish Republic of Norhern Cyprus, Journal of Business Economics and Managemen, 11/1, Kaircioglu, S. (2010b), Inernaional Tourism, Higher Educaion, and Economic Growh: he Case of Norh Cyprus, The World Economy, 33/12,

11 Salih & Elif Kaırcıoğlu Ι 37 Kremers, J. M., Erisccos, N. R. and Dolado, J. J. (1992), The power of coinegraion ess, Oxford Bullein of Economics and Saisics, 5, Kuznes, S. (1966), Economic Growh of Small Naions, he Modern Economic Growh, Yale Universiy Press: London. Oserwald-Lenum, M. (1992), A noe wih quaniles of he asympoic disribuion of he ML co-inegraion rank ess saisics, Oxford Bullein of Economic and Saisics, 5, Phillips, P. C. B. and Perron, P. (1988), Tesing for a uni roo in ime series regression, Biomerica, 75, Sae Planning Organizaion (SPO) (2011), Economic And Social Indicaors, Norh Cyprus: Follow Up And Coordinaion Deparmen, Prime Minisry, Nicosia. Doç. Dr. Salih KATIRCIOĞLU, Doğu Akdeniz Üniversiesi nden İşleme Lisans ve İkisa yüksek lisans derecelerini aldıkan sonra, 2000 yılında, İkisa anabilim dalında Uludağ Üniversiesi nden dokora derecesini almışır. Ekim 2010 arihinden iibaren Doğu Akdeniz Üniversiesi, Bankacılık ve Finans Bölümü başkanlık görevini yürümekedir. Dr. KATIRCIOĞLU nun, bugüne kadar uluslararası dergilerde yayınlanmaya devam emeke olan 60 an fazla eseri mevcuur. Bu eserlerin, yaklaşık 30 anesi Social Sciences Ciaion Index arafından aranan dergilerde yayınlanmış ve yayınlanmak üzere kabul edilmişir. Dr. KATIRCIOĞLU, ayrıca 10 ayrı indeks arafından aranmaka olan Inernaional Journal of Economic Perspecives dergisinin de ediörlüğünü yürümekedir. Salih Turan KATIRCIOGLU (Ph.D) is Associae Professor of Economics in he Deparmen of Banking and Finance of Faculy of Business and Economics, Easern Medierranean Universiy, Famagusa, Norh Cyprus, Via Mersin 10, Turkey. He graduaed from he same insiuion and earned his PhD from Uludag Universiy, Turkey. His research ineress include applied ime series economerics, inernaional rade, inernaional finance, ourism economics, and economic growh issues. He serves as edior in Inernaional Journal of Economic Perspecives. He has previously published in considerable number of inernaional peer review journals such as The World Economy, Applied Economics, Tourism Managemen, Applied Economics Leers, Inernaional Journal of Manpower, Tourism Economics, Singapore, Economic Review, Journal of Business Economics and Managemen, Inernaional Journal of Bank Markeing, and Inernaional Journal of Social Economics.

12 38 Ι Tesing Impor Led- Growh Hypohesis in Norh Cyprus Elif KATIRCIOĞLU, Dokuz Eylül Üniversiesi nden İkisa dalında lisans ve Doğu Akdeniz Üniversiesi nden Bankacılık ve Finans dalında yüksek lisans derecelerini aldıkan sonra, Ingilere de Greenwich Üniversiesi nde dokora eğiimine halen devam emekedir. Sn. KATIRCIOĞLU, Doğu Akdeniz Üniversiesi, İşleme Bölümü nde Girişimcilik, e-ticare, ve İsaisik konularında ders vermeye devam emekedir. Sn. KATIRCIOĞLU aynı zamanda, Inernaional Journal of Economic Perspecives dergisinin yöneici ediörlük görevini de sürdürmekedir. Elif KATIRCIOGLU (MSc) is lecurer in he Deparmen of Business Adminisraion of Faculy of Business and Economics, Easern Medierranean Universiy, Famagusa, Norh Cyprus. She go her maser degree from he Deparmen of Banking and Finance of Faculy of Business and Economics, Easern Medierranean Universiy, Famagusa, Norh Cyprus and her bachelor degree from he Deparmen of Economics in Dokuz Eylul Universiy, Izmir, Turkey. Her research ineress include enrepreneurship and elecronic commerce. She has several chapers in books and aricles published in inernaional peer reviewed journals. She serves as Managing Edior in Inernaional Journal of Economic Perspecives.