EXPORT-IMPORT BANK OF INDIA OCCASIONAL PAPER NO. 150 OPENNESS AND GROWTH OF THE INDIAN ECONOMY: AN EMPIRICAL ANALYSIS This study is based on the award winning entry for EXIM Bank International Economic Development Research Annual (IEDRA) Award 2010 for the doctoral dissertation titled “Openness and Growth of the Indian Economy: An Empirical Analysis”, submitted to the Indian Institute of Technology Bombay, Mumbai by Dr. Narayan Chandra Pradhan, Research Officer, Reserve Bank of India, Mumbai. The dissertation was written under the supervision of Prof. Pushpa Trivedi, and was sponsored by the Reserve Bank of India. The views expressed here are those of the author and do not necessarily reflect those of the Export-Import Bank of India. EXIM Bank’s Occasional Paper Series is an attempt to disseminate the findings of research studies carried out in the Bank. The results of research studies can interest exporters, policy makers, industrialists, export promotion agencies as well as researchers. However, views expressed do not necessarily reflect those of the Bank. While reasonable care has been taken to ensure authenticity of information and data, EXIM Bank accepts no responsibility for authenticity, accuracy or completeness of such items. © Export-Import Bank of India August 2011 1 2 CONTENTS Page No. List of Tables 5 List of Charts 5 Executive Summary 7 1. Introduction 10 2. Trade Openness and Growth: A Brief Survey of Literature 18 3. Openness and Growth: The Role of International Institutions 22 4. India’s Trade Openness, Trade Policy and Growth 27 5. Trade in Services and Growth 39 6. Labour Migration and Financial Flows 49 7. Exports and Economic Growth: An Econometric Analysis 57 8. Nexus between Capital Flows and Growth 73 9. Conclusions 79 Appendix 82 References 90 3 4 LIST OF TABLES Table No. Title Page No. 4.1 Trends in Trade Openness of Major Trading Economies 30 4.2 India’s Trade Performance since 1980 33 4.3 India’s Exports of Principal Commodities 34 4.4 Direction of India’s Exports 35 4.5 India’s Imports of Principal Commodities 36 4.6 Sources of India’s Imports 37 5.1 Indicator of Services in Indian Economy 42 5.2 Structure of India’s Services Exports 43 5.3 Software Services Exports of India 45 6.1 World Remittances 51 6.2 Relative Volatility of Workers’ Remittances 52 6.3 Workers’ Remittances - Top Ten Receiving Countries 53 7.1 ADF and PP Unit Root Tests for the Data Series 61 7.2 KPSS Stationarity Tests 62 7.3 Granger Causality Tests 69 8.1 ADF Unit Root Test 74 8.2 Granger Causality between DLNAGDP and DLCAPFL 78 LIST OF CHARTS Chart No. Title Page No. 4.1 India’s Share of Global Merchandise Exports and Imports 32 5.1 Growth Rate of Total GDP, Services GDP and Services Trade 41 5 6 EXECUTIVE SUMMARY The study focuses on ‘openness’ and affects analysis and policy even which is expected to have a positive in the present day context. impact on the growth of Indian economy. Each chapter deals The role of multilateral international with a theoretical perspective on institutions, such as, WTO, IMF, openness and growth. Although, the World Bank and ILO in promoting background of the study includes the trade openness and growth has post-independence period so as to been discussed in depth. The WTO highlight the lessons learnt from the focuses on rules for multilateral trade import substituting industrialization, liberalization and transparency; the the analytical content focuses on the IMF on overall macroeconomic policy liberalization period beginning the framework and balance of payments 1980s, reinforced during 1990s and disequilibria; and the World Bank carried forward during 2000s. The on long-term growth, development temporal coverage of the empirical and sectoral trade issues. The ILO’s analysis carried out spans the period role has been to ensure that the 1970-71 to 2008-09. The research human face of labourer is not lost in question addressed in the study is: implementing the competitive agenda “whether openness has impacted of trade openness and growth. India’s growth rate, and if so, then in what direction?” In recognition of the growing importance of external openness in An overview of literature on the nexus Indian economy, the focus is assigned between openness and growth reveals on changing trade policy regimes of many aspects. The theories of trade India; trade performance in the global discussed are those based on certain context during the liberalization assumptions and tried to explain: period; changing trade pattern – (i) how and why different countries both composition and direction since may gain from trade; and (ii) pattern of 1980-81 in order to compare pre- trade specialisation, i.e., why certain and post-liberalization performance. countries export particular goods and Services exports have opened up import others. The theory written over new opportunities for India since the a hundred years ago still resonates liberalization process started and 7 seen a structural shift starting from relationship. The coefficient of error 2003-04 driven by the emergence of correction term decides how quickly new avenues – exports of software the equilibrium is restored. About 17 services and business services per cent of disequilibrium is corrected that augur well for the services led every year in the case of relationship growth. between exports of goods and GDP; and about 14 per cent disequilibrium This study puts forward the impact is corrected every year in the case of labour mobility since 1980s. There of relationship between ‘goods and are two major impacts of international services’ and GDP. The significance labour migration from India, on the of the error correction term at 5% balance of payments: (i) through level suggests a robust relationship remittances from migrant labour; and between export growth and growth of (ii) through repatriated deposits held real GDP. This reinforces the nexus with the Indian Banks. In recent years, between export and GDP growth in the world has witnessed migration of both short and long run. The test of labour as a major feature despite the Granger causality suggests that the restrictive immigration laws, owing direction of causality from export growth to GDP growth; since the to the differences in demographic estimated F-statistics is significant, at pressure and income levels among the 5% level up to 4 lags, at the 10% countries. At the same time, spread level at lag 5. On the other hand, there of education and communication are is no ‘reverse causation’ from GDP also facilitating the progress of labour growth to export growth. The test of openness from developing countries Granger causality/Block Exogeneity to developed ones. in VAR framework indicates lead- lag relationship between exports Empirical testing of export-led growth and GDP. The empirical evidence hypothesis by applying various time indicates that the movements in the series techniques reveals both short- exports of goods and services appear and long-run relationship between to lead the movement of GDP in Indian export and output growth. Application economy. This also indicates that one of stationarity/unit root tests, viz., can use exports to better predict the ADF, PP and KPSS, confirms that all GDP than simply by the past history the variables are non-stationary at log of GDP. levels and there is existence of unit root in the series used. Subsequent The Cointegration tests demonstrate residual based cointegration test a long run relationship between net on log levels between exports capital flows and non agricultural and GDP confirms their long run GDP. The Granger causality results, 8 however, do not point out to the Given the recent success of software validation of temporal causation exports from India along with the between net capital inflows and focus area approach to merchandise growth. Hence, based on these tests, exports including its diversification, neither can we make any claims the finding is plausible and consistent about the predictability of growth with prior expectation that growth from capital inflows nor can we infer of exports – both merchandise whether capital inflows have been and services – stimulates economic due to pull factor. growth. 9 1 INTRODUCTION Since 1980s, interdependence endangered the ability of countries to among nation-states has increased insulate themselves from the external significantly in respect of trade to shocks. Gross Domestic Product (GDP) ratios. Now, it is an established fact In the above background of that the growth of world merchandise world economy, the structure of trade has surpassed the growth of Indian economy has undergone a world GDP leading to even doubling considerable change since mid-1991. of the trade-to-GDP ratios for some These changes include, increasing emerging economies between 1980 importance of international trade and and 2008. This has emanated mostly capital flows. The services sector from the increasing openness of the has become a major driver of the world’s trade and financial markets economy with GDP share of more and ongoing labour migration. These than 50 per cent and the country phenomena, in turn, have been becoming an important hub for stimulated by policy efforts, both export of Information and Technology at bilateral and multilateral levels enabled services (ITES). The share through liberalising the rules governing of merchandise trade to GDP in trade and investment and by market India increased from 7.2 per cent in forces that prompt MNCs to seek out 1980-81 to 13.3 per cent in 1990-91 better factor costs and conditions to and further to 38.9 per cent in 2008- site their locations outside the state of 09. India has been perceived as their origin. an attractive destination for capital inflows and net capital inflows, due to With technological change in the various socio-political and economic information sector, huge capital considerations.