CAUSAL RELATIONSHIP BETWEEN SAVINGS AND ECONOMIC GROWTH IN COUNTRIES WITH DIFFERENT INCOME LEVELS. Abstract

Transcription

1 CAUSAL RELATIONSHIP BETWEEN SAVINGS AND ECONOMIC GROWTH IN COUNTRIES WITH DIFFERENT INCOME LEVELS. Ramesh Mohan Bryan Universiy Absrac This paper addresses he relaionship beween domesic savings and economic growh for various economies wih differen income levels. Using ime series annual daa, he Granger causaliy es was conduced. The sudy seeks o deermine wheher he direcion of causaliy in hese economies is differen based on heir income class: namely low income, low middle income, upper middle income, and high income counries. Ciaion: Mohan, Ramesh, (006) "CAUSAL RELATIONSHIP BETWEEN SAVINGS AND ECONOMIC GROWTH IN COUNTRIES WITH DIFFERENT INCOME LEVELS.." Economics Bullein, Vol. 5, No. 3 pp. 1 1 Submied: Sepember 19, 005. Acceped: February 1, 006. URL: hp:// 05E000A.pdf

2 1.0 INTRODUCTION The convenional percepion is ha savings conribue o higher invesmen and hence higher GDP growh in he shor run (Bacha, 1990; DeGregorio, 199; Jappelli and Pagano, 1994). The cenral idea of Lewis s (1955) radiional developmen heory was ha increasing savings would accelerae growh. Kaldor (1956) and Samuelson and Modigliani (1966) sudied how differen savings behaviors induced growh. On he oher hand, many recen sudies have concluded ha economic growh conribues o savings (Sinha and Sinha, 1998; Salz, 1999; Anoruo and Ahmad, 001). Caroll, Overland, and Weil (000) demonsraed ha if uiliy depends parly on how consumpion compares o a habi sock deermined by pas consumpion, an oherwise-sandard growh model can imply ha increases in growh can cause increased saving. Edwards (1995) found ha per capia growh is one of he mos imporan deerminans of boh privae and public savings. To formally examine he relaionship beween savings and economic growh, his sudy invesigaes wheher he causaliy is from savings o economic growh or vice versa. This paper uses Granger causaliy o compare he no causaliy or unidirecional/bi-direcional causaliy relaionship beween savings and economic growh. This sudy also aemps o deermine wheher he income level of he economy plays an imporan role in influencing he direcion of causaliy. This paper differs from oher sudies in he lieraure primarily in dividing he counries under invesigaion ino low-income (LIC), low-middle income (LMC), upper-middle income (UMC) and high-income (HIC). The primary hypohesis ha he sudy inends o es is wheher he income level of he economy influences he direcion of causaliy beween economic growh rae and savings. Furhermore, he sudy includes 5 counries, including en HICs. Typically, HICs have lower savings and economic growh rae. Generally, mos of he lieraure focused on developing counries. Differen savings behaviors, he club convergence heory, or he caching up effec o a higher seady sae level, in differen economies based on heir iniial income per capia, provides a basis o hypohesize differen direcions of causaliy for differen economic income classes. The empirical resul of Quah s (1993) sudy revealed ha middle-income counries are slowly vanishing. The caching up effec, as he counries are in ransiion o reach a similar seady sae as he HICs, provide us a basis o anicipae differen direcions of causaliy. For a HIC, which represens an economy ha is closer o a seady sae, he growh rae is comparaively slower, hus one could expec he direcions of causaliy o differ..0 LITERATURE REVIEW The relaionship beween savings and economic growh is sudied using conemporaneous correlaion and dynamic models. In his secion, some of he sudies ha aemped o correlae he savings rae and economic growh are presened. Bacha (1990), Oani and Villanueva (1990), DeGregorio (199), and Jappelli and Pagano (1994) conduced Ordinary Leas Squares (OLS) regression on cross-secion daa and concluded ha a higher savings rae (raio of savings o GDP) led o higher economic growh. A recen sudy of 3 counries by Krieckhaus (00) noes ha a higher level of naional savings led o higher invesmen and consequenly caused higher economic growh. Many recen sudies focused on he dynamic relaionship of savings and economic growh using he concep of Granger causaliy. Caroll and Weil (1994), using five-year averages 1

3 of he economic growh rae and savings for OECD counries as well as a larger sample, found ha economic growh rae Granger caused savings in he larger sample. On he oher hand, when ime dummies were no included, savings Granger caused growh in he OECD counries. However, Aanasio e al. (000) criicized he robusness of Caroll and Weil s resuls, finding ha using annual daa raher han he five-year average increased precision and saisical significance of he esimaes as well as changing he paern of causaion. Sinha (1996) presened evidence ha economic growh Granger causes growh rae of savings in Pakisan. Furher, Sinha and Sinha (1998) found ha causaliy was from he economic growh rae o growh rae of savings in Mexico. Sinha (1999) examined he relaionship beween he growh rae of savings and economic growh in Sri Lanka. In his sudy, he causaliy was from growh raes of gross domesic savings o economic growh rae. However, Sinha (000) did similar sudies in he Philippines and found causaliy from economic growh rae o growh rae of domesic savings. Salz (1999) argued ha he higher he income per capia, he higher he consumpion and savings raes. This sudy invesigaed he direcion of causaliy in 17 hird world counries, using he Vecor Error Correcion (VEC) model for eigh counries and Vecor Auo Regressive (VAR) model for he oher nine counries. The sudy found ha for nine counries he causaliy was from he economic growh rae o growh rae of savings. For only wo counries was he direcion of causaliy reversed. There were four counries where no causaliy was idenified, and for he oher wo counries bidirecional causaliy was deeced. The auhor concluded ha higher growh raes of real GDP conribue o a higher growh of savings. Anoruo and Ahmad (001) invesigaed he causaliy of savings and economic growh in seven African counries using VEC. The auhors found ha in four ou of seven counries, economic growh Granger causes he growh rae of domesic savings. However, hey obained a bi-direcional causaliy in Coe d Ivoire and Souh Africa. Only in he Congo, did he opposie resul prevail: he growh rae of domesic savings Granger caused economic growh. Mavroas and Kelly (001) used he Toda and Yamamoo mehod o es for Granger causaliy. Using daa from India and Sri Lanka, he relaionships among gross domesic produc, gross domesic savings, and privae savings was examined in his sudy. The auhors found no causaliy beween GDP growh and privae savings in India. However, bi-direcional causaliy was found in Sri Lanka. Baharumshah e al. (003) invesigaed growh rae of savings behavior in five Asian counries: Singapore, Souh Korea, Malaysia, Thailand, and he Philippines. Based on ime series daa from , using VEC, he auhors found ha growh rae of savings does no Granger cause economic growh rae in he counries, excep for Singapore. 3.0 DATA The curren sudy used annual daa from 1960 o 001. All daa came from World Developmen Indicaors online 003. Some of he missing observaions were updaed wih comparable daa from he World Bank Inernaional Financial Saisics or saisical offices in respecive counries. Variables used in his sudy and he definiions are LogGDS (log of Gross Domesic Savings) and LogGDP (log of Gross Domesic Produc). Gross domesic savings are calculaed as GDP less final consumpion expendiure (oal consumpion). GDP is he sum of gross value added by all residen producers in he economy plus any produc axes and minus any subsidies no included in he value of he producs. I is

4 calculaed wihou making deducions for depreciaion of fabricaed asses or for depleion and degradaion of naural resources. The aim of his sudy is o idenify he causaliy beween he wo variables in each counry. Thus, all he daa used are in erms of a consan local currency uni (consan LCU). The counries for each income class were seleced based on daa availabiliy. The number of counries seleced in each income class is limied because of missing observaions or missing variables. 4.0 EMPIRICAL METHODOLOGY Granger (1969, 1980) became well known for his GC es. He developed Rober Wiener s idea ino a general definiion of cause in dynamic sochasic sysems (Hoover, 1988). The GC mehod regresses variable X on is own lagged values (X -i ) and he lagged values of anoher variable Y (Y -i ). Thus, serial correlaion in he pair of variables is eliminaed, and all ha remains is he correlaion beween hem. If he coefficiens of he lagged values of Y are significan, hen Y Granger causes X. Similarly, o subsaniae he reverse possibiliy, one regresses Y on is own lagged values and lagged values of X. X Granger causes Y if he coefficiens of he lagged values of X are significan. In summary, GC ess can be placed in one of four caegories: No causaliy, X causes Y only, Y causes X only, and a bi-direcional causaliy, i.e., X causes Y and Y causes X simulaneously. Though Granger mus be credied for laying he foundaion, work by Sims (197, 1980) helped promoe and operaionalize he GC es. Though many economericians criicize he GC es, primarily due o problems of misleading inference, i is sill imporan in helping o ascerain wheher he curren value of X influences fuure values of Y when Y s pas is considered. 1 The following are an overview of he seps involved in implemening he GC es. Deail descripions of each sep will follow in he subsequen secions: i. Tes for he presence of a uni roo using Augmened Dickey-Fuller Tes (ADF). ii. Difference he daa in he presence of uni roo and conduc he ADF es again on he differenced daa. iii. Exclude he counries where one of he variables is non-saionary and he oher is saionary. iv. Esimae co-inegraion using he same order of inegraed variables. v. Based on he co-inegraion resuls, use VAR or VEC o es causaliy. The firs sep in he esing procedure is o deermine wheher he daa have uni roos indicaing he daa is non-saionary. To formally es for he presence of a uni roo, he ADF es is used. The regression equaions below are used o es for a uni roo. where p 1 + ηi 1+ i + ε = β X (8) p 1 + ηi 1+ i + ε = α o + β X (9) p 1 + δ + η i 1+ i + ε = α o + β X (10) is he firs difference operaor 1 See Zelner (1988) for a deailed discussion. 3

5 X is loggdp (or loggds) p is he maximum lag lengh ε is he saionary random error is he ime. In he absence of deerminisic elemens, α o he drif erm (inercep), and δ he linear ime rend, equaion 8 is a es for pure random walk. Basically, one would use he mos general case and esimae a regression wih boh he drif erm and linear ime rend (equaion 10), and sep-by-sep esimae he resriced equaions 9 and 8, if he ess fail o rejec he null hypohesis. The null hypoheses is ha β=0 (uni roo presen). If β is negaive and saisically significan, his indicaes ha he series has no uni roo or is saionary. In choosing maximum augmened lag lengh level p, six augmenaion erms were used, and he lag-lengh is chosen based on he Schwarz Bayesian Crierion (SBC). Table 1 shows he ADF es resuls, indicaing ha LogGDP and LogGDS are non-saionary for ou of he 5 counries under invesigaion. In he presence of uni roos, LogGDP and LogGDS need o be firs differenced. Resuls of esing he null hypohesis of he differenced series (DlogGDP and DlogGDS) are also given in Table 1. The resuls indicae ha he uni roo null hypohesis can be rejeced a he 1% or 5% level in all bu hree cases of he differenced series. This implies ha boh variables are saionary afer convering he series hrough firs differencing. For Egyp, Malaysia, and he Unied Saes, one of he variables is non-saionary and he oher is saionary. These hree counries need o be excluded from he analysis because he causaliy es would lead o misspecificaion. The asympoic disribuions of he Granger causaliy es saisics are nonsandard wih non-saionary ime series. Given he resuls of uni roos, he second sep is o esimae co-inegraion using he same order of inegraed variables. Each of he wo variables ha is I(1) in he economies needs o be esed for co-inegraion. 3 To es for co-inegraion, he Johansen (1988) mehod was applied. The following λ race and λ max es saisics were used o esimae he co-inegraion rank r, i.e., he number of independen co-inegraing vecor. n λ race (r) = T ln (1 λ i) (11) r+ 1 λ max (r, r+1) = T ln( 1 λ r+ 1) (1) where λ i is he esimaed values of characerisic roo or he eigenvalues. T is he number of usable observaions. For λ race saisics, he null hypohesis is ha he number of co-inegraing vecors is less han or equal o r agains a general alernaive. For example, if r = 0, a general alernaive is r = 1,,3,4.. For he λ max saisics, he null hypohesis is he number of co-inegraing vecors r agains he alernaive co-inegraing vecors r + 1. For example, if r = 0, he alernaive is r = 1. To es he hypohesis, Johansen criical values able based on simulaion was used. The disribuion of he saisics is subjec o wheher a consan or a drif erm is included in he coinegraing vecor and he number of non-saionary componens under he null hypohesis. A series is inegraed of order (d) or I(d), if afer being differenced d imes, i becomes saionary. 3 In he case where X and Y are boh I(d) and linear combinaion exiss, Z = ax + by, and characerisic roos (c<0), X and Y are co-inegraed. 4

6 The resuls of he Johansen es are presened in Table 3. If he rank of r is zero, he variables are no co-inegraed. The null hypohesis of no co-inegraion was rejeced a a maximum of one or wo co-inegraing vecor a he lag lengh of p = or 4 for he 18 counries. The wo variables are no co-inegraed for Nigeria, Chile, Colombia, and Canada. 4 The VAR mehod would be used o invesigae causaliy in hese four counries. On he oher hand, for he 18 counries for which he wo variables are co-inegraed, he VEC was used o es causaliy. The VAR model can be wrien as he following: log GDP s β1 φ11i φ1i GDP i e1 d = + d + (13) log GDS β 1 φ 1i φ i GDS i e where d is he firs difference or (1-L). e i is he whie noise error. s is he opimal lag lengh obained from he SBC. Deermining appropriae lag lengh is imporan because a small value of opimal lag lengh s would lead o a misspecified model. On he oher hand, a larger value of s would wase degrees of freedom. Usually for quarerly daa, a lag lengh of 1 would be a good saring poin. In his sudy, he daa were available only annually; so a lag lengh of six was chosen. In all he counries under invesigaion, he opimal lag lengh was less han hree. The following SBC crierion was used o deermine he appropriae lag lengh: SBC = T log + N log( T ) (14) where = deerminan of he variance/covariance marix of he residuals. N = oal number of parameers esimaed in all equaions. If he lag lengh is s, each of he n equaions has ns coefficiens plus he inercep, N = n s + n. Chrisiano and Ljungquis (1988) poined ou ha if he variables are co-inegraed, a VAR model in differences is misspecified. The VEC model suggesed by Engle and Granger (1987) is he appropriae choice and can be wrien as follows: log GDP s β1 φ11i φ1i log GDP i λ1 e1 d = + d + [ Z 1 ] + (15) log GDS β 1 φ 1i φi log GDS i λ e where, d is he firs difference or (1-L). e i is he whie noise error. s is he opimal lag lengh obained from he SBC as above. Z -1 is he error correcion erm lagged by one period (co-inegraion vecor from Johansen es). 5.0 EMPIRICAL ANALYSIS The hypohesis in he inroducion of his sudy esed he direcion of causaliy beween economic growh and savings in differen economic income classes. The ADF es indicaes ha boh loggdp and loggds have uni roos in he level daa. In he presence of uni roos, he variables need o be differenced in order for he series o be saionary. Wihou differencing he daa, a causaliy es would lead o misspecificaion. By differencing loggds, he series becomes 4 Based on Enders (1995) p.393, he conclusion was drawn for Nigeria and Colombia on he basis ha λ max es has a beer alernaive hypohesis and is preferred. 5

7 he growh raes of savings. Because of his echnicaliy in he esimaion issue, insead of looking a he causaion direcion beween savings and economic growh, he hypohesis focuses insead on causaion direcion beween he growh raes of savings and economic growh rae in counries wih differen income level. Previous sudies have eiher used gross domesic savings or raio of savings o GDP (S/Y). Mos of hese sudies used simple OLS esimaion and cross-secion daa. Recen sudies ha use he Granger causaliy es o deermine he relaionship beween savings and economic growh have o use he growh rae of savings, insead of savings, because of he uni roo (nonsaionary) problem. The asympoic disribuions of he Granger causaliy es saisics are nonsandard wih non-saionary ime series. Using he resuls of he Johansen es in Table, he loggdp and he loggds of 18 counries ha were co-inegraed were esimaed using he VEC model. In he four economies for which LogGDP and LogGDS were no co-inegraed, VAR was used o esimae he Granger causaliy. In looking a all he resuls in Table 3, only wo counries (India and Ecuador) showed no obvious causaliy in eiher direcion. Overall empirical resuls revealed ha he economic growh rae Granger caused he growh rae of savings in 13 counries. On he oher hand, in wo cases (Indonesia and Singapore) he growh rae of savings Granger caused economic growh rae. Finally, five naions showed a bi-direcional causaliy. In he shor run, he radiional view is ha higher savings leads o higher invesmen and higher economic growh. The empirical resuls, however, do no provide evidence supporing he convenional view. Insead, in mos counries under invesigaion, he empirical resuls show ha he causaliy is from economic growh rae o growh rae of savings. This finding is in agreemen wih Sinha and Sinha (1998), Salz (1999), Sinha (1999), Sinha (000), Anoruo and Ahmad (001), and Baharumshah e al. (003). Turning o he resuls according o economic income class of counries, he major poins o noe are as follows: for he nine HICs under invesigaion (Unied Saes excluded), he empirical resuls provide some evidence on he direcion of causaliy. For eigh counries, he causaliy runs from economic growh rae o growh rae of savings. Only in Singapore, does he causaliy run from growh rae of savings o economic growh rae. The resul is no surprising because Singapore has he forced savings sysem, Cenral Providen Fund. 5 In addiion, gross domesic savings as a percenage of GDP in Singapore is around 50%, one of he highes savings raes in he world. In UMCs (excluding Malaysia), he empirical resuls indicae ha all of he counries show a bi-direcional causaliy. This is an ineresing finding since World Bank (1999) showed ha he savings and economic growh for UMCs are generally high. The empirical resuls perhaps sugges ha he counries are in ransiion o reach a similar seady sae as he HICs. This is consisen wih Quah s (1993) sudy, which revealed ha middle-income counries are slowly vanishing. Empirical resuls for LMCs also favor he noion ha he causaliy runs from economic growh rae o growh rae of savings. Economic growh rae Granger causes growh rae of savings in Algeria, Thailand, and Colombia. However, here appears o be no causal relaionship beween he wo variables in Ecuador. In all he LMCs under invesigaion (excluding Egyp), none show a causaliy ha runs from growh rae of savings o economic growh rae. 5 In his enforced savings plan 40% of an employee s wages is saved; he employee conribues 0%, and he employer maches wih anoher 0%. 6

8 In LICs, he empirical resuls were mixed. Senegal and Nigeria have a causaliy ha runs from economic growh rae o growh rae of savings. However, no causal relaionship exiss in India. Only in Coe d Ivoire was a bi-direcional relaionship found. These mixed resuls are probably correlaed wih he income divergence; Baumol (1986) empirically found ha lowincome counries diverge over ime. The primary goal of his sudy was o deermine wheher he direcion of causaliy differs for counries wih differen income: namely LICs, LMCs, UMCs, and HICs. Based on he empirical resuls, he main conclusion of his sudy is ha in LICs, a firm conclusion canno be drawn in deermining he direcion of causaliy. In all of he LMCs, he causaliy is from economic growh rae o growh rae of savings. In all of he HICs, excep Singapore, he causaliy is from economic growh rae o growh rae of savings. However, i appears ha in UMCs bi-direcional causaliy is more prevalen. The empirical evidence appears o favor he hypohesis ha he economic growh rae causes growh rae of savings. In Table 3 is a summary of he direcion of causaliy based on he empirical resuls. 6.0 CONCLUSION Theoreically, he Solow model and he club convergence heory provide a basis for expecing differen causaliy for various income per capia levels. A number of cross-counry sudies showed he caching up effec o various clubs based on a naion s iniial per capia income. The primary purpose of his paper was o invesigae he relaionship beween he domesic savings and economic growh for various economies. Using ime series annual daa, Granger causaliy ess were conduced. The objecive was o deermine wheher he direcion of causaliy in hese economies differed according o heir income class: namely LIC, LMC, UMC, and HIC. In general, empirical resuls sugges ha he economic growh rae Granger causes growh rae of savings in 13 counries. The opposie resuls prevailed in wo counries. In five counries, a bi-direcional causaion was found. In his sudy, he direcion of causaliy is somewha consisen wih he heory, especially in he case of UMCs and HICs. In summary, based on he resuls, he sudy favors he hypohesis ha he causaliy is from economic growh rae o growh rae of savings. Based on he empirical resuls, he main conclusion of his sudy is ha income class of a counry does play an imporan role in deermining he direcion of causaliy. In LICs he empirical resuls were mixed. In mos of LMCs, he causaliy is from economic growh rae o growh rae of savings. In all HICs excep Singapore, he causaliy is from economic growh rae o growh rae of savings. However, i appears ha in UMCs, bi-direcional causaliy is more prevalen.. 7

9 Table 1: Resuls of ADF Tes Ho: Uni roo vs H1: No uni roo Low-Income (LIC) Coe d'ivoire Indonesia India Nigeria Senegal Variable ADF ADF ADF ADF ADF LogGDP D(LogGDP) Log GDS D(LogGDS) Lower-Middle income (LMC) Algeria Colombia Ecuador Egyp Thailand Variable ADF ADF ADF ADF ADF LogGDP D(LogGDP) Log GDS D(LogGDS) Upper-Middle Income (UMC) Argenina Brazil Chile Malaysia Souh Africa Variable ADF ADF ADF ADF ADF LogGDP D(LogGDP) LogGDS D(LogGDS) High-Income (HIC) Canada Finland Iceland Japan Korea Variable ADF ADF ADF ADF ADF LogGDP D(LogGDP) LogGDS D(LogGDS) Norway Singapore Sweden Unied Kingdom Unied Saes Variable ADF ADF ADF ADF ADF LogGDP D(LogGDP) LogGDS D(LogGDS) Noe: ADF regression equaion: = α o + β X p 1 + δ + ηi 1+ i + ε denoes significan a 1% criical value. denoes significan a 5% criical value. LogGDP and LogGDS are series in level. D(LogGDP) and D(logGDS) are firs differenced series. 8

10 Table : Co-inegraion Resuls Counry λtrace max India Indonesia Senegal Coe d Ivoire Nigeria # Algeria Thailand Colombia # Ecuador Souh Africa Brazil Argenina Chile Norway Canada Japan Singapore Korea Unied Kingdom Finland Iceland Sweden Noe:, denoe significan a 1% and 5%, respecively. # According o Enders (1995) λ max es has a beer alernaive hypohesis and preferred. 9

11 Table 3: Granger Causaliy Resuls Based on Income Classificaion Counry Growh rae of savings o economic growh rae Low- Income (LIC) India No No Indonesia Yes No Senegal No Yes Coe d Ivoire Yes # Yes # Nigeria No Yes Lower-Middle Income (LMC) Algeria No Yes Thailand No Yes Colombia No Yes Ecuador No No Egyp Upper-Middle Income (UMC) Malaysia Souh Africa Yes # Yes # Brazil Yes# Yes# Argenina Yes # Yes # Chile Yes # Yes # Economic growh rae o growh rae of savings High-Income (HIC) Unied Saes Norway No Yes Canada No Yes Japan No Yes Singapore Yes No Korea No Yes Unied Kingdom No Yes Finland No Yes Iceland No Yes Sweden No Yes Noe: # bi-direcional causaliy -- excluded 10

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