The Relationship between Growth and Foreign Trade during the Debt

The Relationship between Growth and Foreign Trade during the Debt Crisis: A
Causality Analysis on the Eurozone Countries
FatihKonur
AbantİzzetBaysal University, Faculty of Economics and Administrative Sciences, Department
of Economics, Bolu / Turkiye
Phone: +9-0-374 254 10 00 / 15 09; Fax: +9-0-374 253 45 21
E-mail: [email protected]
Kemal Çakıcı
International Finance Corporation, The World Bank Group, USA
Phone: +1-202-412-2645; Fax: +1-202-522-7419
E-mail: [email protected]
Abstract
The global financial crisis that occurred in the aftermath of fall of 2008 was often
characterized as the most severe one since the Great Depression. The first crisis that affected
the economic and monetary union was an important indicator for the Euro and the Eurozone
Countries. Exhausted traditional monetary instruments, insolvency and liquidity challenges,
toxic assets in the European Central Bank, front-loaded austerity measures, inadequate fiscal
support, and lack of pro-growth policies are among the problems during the global financial
crisis. The aim of this study is to investigate the effects of the debt crisis on the growth and
foreign trade on some Eurozone Countries. We will analyze selected macroeconomic
indicators for selected countries before and after the crisis and then we will performa Panel
Granger Causality Test for export, import, GDP data’s of selected Eurozone countries for the
2007Q3:2012Q2 period and discuss the results.
JEL Code:F0, F43, G01
Keywords:Global Financial Crisis, Economic and Monetary Union, Foreign Trade, Growth,
Panel Granger Causality.
1. Introduction
The capacity of the Euro Area countries to withstand contradictory macroeconomic and
financial shocks was recognized as a major challenge for the success of the European
Monetary Union(EMU) from the beginning. By swapping off the choice for national currency
devaluations, a customary change means between national economies was eliminated (Lane,
2012:49).
The debt crisis has influencedthe European Union (EU)negatively. Many countries have been
compelled to resort to austerity measures not seenin recent decades. Drastic spending cuts, tax
increases, and structural reforms have led to growing economic challenges, especially in
Southern and Eastern Europe.The global financial crisisand theEuropean debt crisislead to a
critical dispute to the European and international economies. The crisis has dispersed from its
initial epicenter in Greece to Ireland and Portugal and, most recently to Spain and Italy
(Cline, 2011:1).
The EU has been terriblybruised by the last debt crisis. Europe’s single currency, long
applauded as an important symbol for Europe’s harmony and theforemost source of
integration, has unleashed highly discordant dynamics. For some Eurozone members, it has
become a real and major foundationof their financial difficulties. EU’s debt crisis
management is verified to be exceptionally slow and is subject to much controversy. While
the method of European unification has witnessed numerous adversities in past decades, the
current position is more critical than any before (Möckli, 2012:1).
Since the beginning of the Euro crisis, governments changed frequently in Greece, Italy,
Ireland, Portugal, and Spain. So far, changesin the governments have not worked against the
reformprograms. Nevertheless, the implementation of reformprograms faces serious political
risks, especially on the discussionsof the future of European Union (Deloitte, 2012:8).
The purposeof this study is to investigate the effects of the debt crisis on the growth and
foreign trade on selected Eurozone Countries. The first section of this paper attempts to
analyze a set of macroeconomic indicators for selected countries before and after the crisis.
The second section provides a literature review on previous studies and summarizes their
results. The third section attempts to summarize the Panel Granger Causality Test results for
export, import, and GDP data’s of selected Eurozone countries.
2. The Effects of Crisis on Selected Macroeconomic Indicators
A key question is whether the international economies are just striking another bout of
turbulence in what was habitually anticipated to be a slow and bumpy recovery or if the
present slowdown has a more lasting component. The response depends on if the European
and the United States’ policymakers deal proactively with their foremost short-term financial
challenges (IMF, 2012:1).
Notwithstanding policy action focused at resolvingit, the Euro Area crisis has deepened and
new measuresare necessary to prevent mattersfrom declining even further.Activity is
contracting, mainly due to deep cutbacks in production in the periphery economies, because
financial and fiscal conditions are very tight. Additionally, sovereign issuers and banks in the
periphery are struggling to attract foreign investors. Their sovereign debt spreads have risen
significantly, and their banks rely increasingly on the European Central Bank (ECB) for
funding (IMF, 2012:3-4).
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Graph 1.GDP (% real change pa)
* Data’s after 2012Q2 are estimates.
Source: The Economist Intelligence Unit, Country Data - Quarterly Indicators, 2012.
The effects of the Euro Area crisis can be seen on the quarterly growth rates of selected
countries in Graph 1. Following a number of shocks in 2011, the EUeconomy entered a period
of contraction at the endof 2011. The sharp increase in oil prices, aslowdown in the world
economy, and, last but notthe least, the negative impact of the escalation of thesovereign-debt
crisis in several Member Statesresulted in a sharp deterioration of the economicsituation
towards the end of 2011 (EC, 2012:24). According to estimates by Eurostat, GDP fell by
0.2% in both the Euro Area (EA17) and the EU27 during the second quarter of 2012. In the
first quarter of 2012, growth rates were flat at 0.0% in both zones (Eurostat, 2012:1). Greece’s
GDP contracted 6.30%in the second quarter of 2012 over the same quarter of 2011.
Historically, from 2005Q1 until 2007Q4, Greece had an average positive GDP
quarterlygrowth whereas, a record low of -8.1% was observed in 2010Q1.
In the same graph we can see that Ireland’s economic activity dropped sharply in 2008 and
Ireland went into a recession for the first time in more than a decade with the onset of the
global financial crisis and subsequent critical slowdown in the property and construction
markets.
Italian economic activity slowed down throughout the third quarter of 2012, with slightly less
gloomy indications in September. It contracted by 0.8 percent in the second quarter of 2012,
and contraction continuedduring the summer months, though less sharply. The weakness of
consumption and investment demand reflect still a tense economic situation, the consequences
of budget measures on disposable income, and the feeble self-assurance of households and
firms. Business surveys in September displayed indications of a minor increase of optimism
over the short-term expectations, but not sufficient to warrant a direct come back to growth
(BancaD’Italia, 2012). Italia’s quarterly GDP data changed with same movements as Spain’s
in the period from 2005 to 2012.
The Portuguese GDPcontracted in 2009 and 2011, compared with previous quarters. It
registered a year-on-year change rate of -2.2% in volume in the first quarter 2012 (-2.9% in
the previous quarter). This evolution was propelled by a less contradictory contribution of
domesticdemand. The affirmative contribution of net external demand turned negative, as
imports of goods and services registered a lessintense negative year-on-year change rate than
in the fourth quarter of 2011, in spite of the slight acceleration of exportsof goods and
services.
The Spanish economy grew every year from 2005 through 2008 before entering a recession
that started in the third quarter of 2008. Forecasts point towarda 1.3% contraction of GDP in
2012, and a slow recovery in 2013, which could come faster if the announced structural
reforms are ambitious enough (BBVAR, 2012:3).
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Graph 2. Consumer prices (% change pa; av)
* Data’s after 2012Q2 are estimates.
Source: The Economist Intelligence Unit, Country Data - Quarterly Indicators, 2012.
The effects of the debt crisis can be seen on the quarterly consumer prices data on a set of
selected countries in Graph 2.Consumer prices in 2011 were mostly propelled by the passthrough effect of increasingglobal commodity prices and, by increases inthe indirect taxes and
administered prices. Inflation temporarily exceeded3% in 2011, but started to recede in the
light of a weakening economicenvironment. The easing in commodity prices as indicated by
commoditiesfutures toward the end of this year and relative weak economic activityshould
lower consumer-price inflation further. A faster down turn in inflationrates is precluded by
fiscal measures adopted in several countries, mostnotably in increases in indirect taxes and
administered prices. The comeback ofsubdued growth in late 2012 and 2013 is not expected
to contribute to pricepressuresin particular since output gaps are expected to narrow very
slowlyin the EU and the euro area. Inflation is forecasted to stay closeto 2% in 2013 in the EU
and the euro area (EC, 2012:4).
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Graph 3.Industrial production (% change pa)
Source: The Economist Intelligence Unit, Country Data - Quarterly Indicators, 2012.
The effects of the crisis can be seen on the quarterly industrial production data on selected
countries in Graph 3.The three-month moving averagegrowth rate of industrial production
came in at -0.9% and -1.1% forthe EU and the euro area respectively, which sent a less
positivesignal for the overall economic activity in the firstquarter of 2012.Indicators that actas
a gauge of future activity havebeen rather weak in the past several months. Industrialnew
orders have been on a downward trend sinceautumn of 2011, standing at about 10% below the
2007average in February 2012. This limits expectationsfor aearly rebound in industrial
production and does not bode well for the overall economic growth inthe near term (EC,
2012:25).
The crisis affected the industrial production in Spain and Italy, most notably in 2009. Portugal
and Greece both have a contraction of 11 percent in 2009. Ireland’s fluctuating growth in
industrial production can also be seen on graph 3.
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Graph 4.Trade balance (fob-cif basis)
Source: The Economist Intelligence Unit, Country Data - Quarterly Indicators, 2012.
The trade balances of selected EU members are shown on graph 4. The trade balances of the
euro area and the EUwere massively impacted by the increase in importprices in 2011. In both
areas, the balance shrank,falling to 1/2 % of GDP in both the EU and theeuro area. The effects
on the external balances werepartially offset by a larger surplus in the servicesbalance, which
widened the total surplus in theexternal balances of both areas. Overall, the currentaccount
moved closer to a balance in 2011 (EC, 2012:34). Spanish economy has more deficits than
others. Since the crisis in 2007, Spain has dramatic rates,Ireland has surpluses despite the
economic crisis. The recovery in Italian trade started with the first quarter of 2012.
3. Theoretical Framework
This paper investigates the potential Granger causality among the real GDP, real imports and
exports in selected EU countries for the period between 2007 and 2012 using quarterly
data.The relationship between economicgrowth and foreign trade (exports-imports) can be
emphasized in three ways;.Export-led growth (ELG);Growth-led export (GLE); and Importled growth (ILG).
The relation between exports and economic growth has received a great deal of attentionin
international economics research. Basic economic theory states that the increase in exports
contributes to economic growth first through the foreign trade multiplier effect (Stolper,
1947). The foreign trade multiplier theory claims that, given the spending function, an export
surplus will have a positive effect whose magnitude depends on the marginal propensity to
import. Transfer of scarce production factors from low-productivity domestic industries to
higher-productivity export industries results in an increase in productivity, accelerating output
growth. Economic theory also suggests that a higher level of exports might contribute to
economic growth as export revenues provide a significant source of foreign exchange, which
is crucial when domestic savings are insufficient for making imports of capital goods
possible. Finally, export growth might also initiate economic growth through the expansion of
the efficient market size, bringing in substantial economies of scale that accelerate the rate of
capital formation and technical change (Tekin, 2012:869).
However, there are logical arguments for reverse causality resulting withGLE hypothesis.
Bhagwati (1988) indicates that an increase in GDP generally results in a corresponding
expansion of trade, unless growth induces supply and the corresponding demand creates an
anti-trade bias. Moreover, economic growth may have little to do with government policy to
promote exports, rather than being related to the accumulation of cumulative production
experience, human capital, and technology transfer from abroad or physical capital
accumulation (Jung and Marshall, 1985). Finally, Giles and Williams (2000) argue that
economic growth may lead to the enhancement of skills and technology which creates a
comparative advantage and thereby facilitates exports, while higher output growth can
stimulate higher investment, a part of which can be for increasing export capacity (Kemal et
al., 2002).
The ILG hypothesis proposes that economic growth could be propelled mainly by growth in
imports (Henriques and Sadorsky, 1996; Ribeiro Ramos, 2001). Endogenous growth models
show that imports can be a conduit for long-run economic growth because it presents
domestic firms with access to needed intermediate goods and foreign technology (Coe and
Helpman, 1995). Growth in imports can serve for the transfer of growth-enhancing foreign
R&D knowledge (Lawrence and Weinstein, 1999; Mazumdar, 2000).
4. Data
The data’s used in this study are taken from the database of the Economist Intelligence Unit.
Quarterly import, export and gross domestic product (GDP) variables were used covering the
2007:Q3-2012:Q2 period. All data wereconvertedtologarithmicscalepriorto analysis.
5. Empirical Analysis and the Results
First, the seasonally adjusted time series data were examined using stationarity tests. The
results obtained using Levin, Lin & Chu method in Eviews 6 reported in table 1. The
calculated statistics for each variable is greater than the critical value of -1.96 from the
standard t-table. Therefore, the null hypothesis of non-stationary cannot be rejected.
Table 1. Unit Root Test Results
Variable
Level
1st differences
LnGDP
-1.83
-2.49*
LnEXP
-0.13
-2.17*
LnIMP
-2.58*
-
* denotes signifance
The lag length was found to be 4. ThePanel GrangerCausality Test determinethedirection of
relationship between variables andthe analysis was done and the results are shown in table 2.
Table 2. Panel Granger Causality Test Results
Null Hypothesis:
Obs
F-Statistic
Prob.
EXPORT does not Granger Cause GDP
GDP does not Granger Cause EXPORT
75
9.66811
3.28640
3.E-06
0.0162
IMPORT does not Granger Cause GDP
GDP does not Granger Cause IMPORT
75
2.61216
3.14748
0.0431
0.0198
According to results, we conclude that there is a one-way causality from gross domestic
product (GDP) to exports and a bi-directional causality between imports and GDP.
6. Summary and Concluding Remarks
The Great Recessionin 2008-09 and the sovereign-debt crisis affected Greece, Ireland,
Portugal, Spain and Italy. As indicated in European Commission’s report, both crisis imply a
very slowrecovery for the selected economies characterized by growth below potential over
most of the forecast horizon, insufficient employmentdynamics and persistent growth
differentials across the European Union. Recent experience shows that recoveries from
financial crises are not only slow and uneven, but also oftensubject to episodes of renewed
weakness and financial market stress.
The macroeconomic data analyzed in this paper clearly shows that the impacts of the crisis on
selected countries are negative. The trade balances ofGreece, Ireland, Portugal, Spain and
Italy massively affected since 2007.
In this article, we have used panel granger causality tests to investigate the relationship
between GDP and trade in selected countriesduring2007:Q3 and 2012:Q2 for reflecting the
negative effects of the crisis. The main results are:
-
there is some evidence of a significant relationship between GDP and exports,
-
and evidence of a significant bi-directional relationship between GDP and imports in
the selected period.
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