Economic Modelling 22 (2005) 423 – 438

www.elsevier.com/locate/econbase

Estimating income and price elasticities of imports

for Fiji in a cointegration framework
Paresh Kumar Narayan*, Seema Narayan
Department of Accounting, Finance and Economics, Griffith Business School, Griffith University,
Gold Coast Campus, PMB 50 Gold Coast MC, Queensland 9726, Australia
Accepted 18 June 2004

Abstract

This paper estimates an import demand model for Fiji using the recently developed bounds
testing approach to cointegration for the period 1972 to 1999. To estimate the long-run elasticities,
we use three approaches: the autoregressive distributed lag (ARDL) model, the dynamic ordinary
least squares (DOLS) approach and the fully modified ordinary least squares technique. Our results
indicate a long-run cointegration relationship among the variables when import volume is the
dependent variable. We find that the coefficient on income is elastic while the coefficient on relative
prices (import price relative to domestic price) is unitary elastic in the long run. The error correction
mechanism reveals that after any shock(s) to the determinants of import demand equilibrium is
attained after 2 1/2 years.
D 2004 Elsevier B.V. All rights reserved.

JEL classification: C22; F1

Keywords: Fiji; Import demand; Cointegration

1. Introduction

Fiji is a small island country in the South Pacific with a population of 0.824 million in
2001. It is classified as a lower middle income country with real Gross Domestic Product

* Corresponding author. Tel.: +617 5552 8056; fax: +617 5552 8068.
E-mail address: P.Narayan@Griffith.edu.au (P.K. Narayan).

0264-9993/$ - see front matter D 2004 Elsevier B.V. All rights reserved.
doi:10.1016/j.econmod.2004.06.004
424 P.K. Narayan, S. Narayan / Economic Modelling 22 (2005) 423–438

(GDP) per capita ($US) in 2001 of US$2130 (World Bank 2002). However, Fiji’s social
development indicators are quite high. In 1999, life expectancy was 68.8 years and the
overall literacy rate was 92.6% (United Nations Development Programme UNDP, 2001).
Fiji’s macroeconomic fundamentals are also reasonably stable. For instance, inflation has
never exploded out of bounds—it has remained at around 2–3% per annum; and its foreign
reserves are healthy, enough to cover 5–6 months of import payments. However, exchange
rate, which is fixed to the basket of countries consisting of Fiji’s major trading partner
countries, has been unstable over the last couple of decades. During the 1987–1999 period,
the Fiji dollar depreciated drastically against the major trading partner countries. This
eventuated when, in the face of widening current account deficits, the Fiji dollar was
devalued by 30% in 1987 and by 20% in 1998. Fiji’s budget, like current account deficits,
has also been in persistent deficits.
From the time it obtained independence in 1970 up until the mid-1980s, Fiji pursued
import substitution policies. Since the mid-1980s, however, with the advent of the
International Monetary Fund’s structural adjustment policies, Fiji has vigorously followed
export promotion policies. Hence, Fiji’s economy became more open. The economy
depends in large part on sugar, garment and tourism exports which together make up 30%
of Fiji’s real GDP and employ around 100,000 people. Generally, Fiji’s growth performance
has been quite poor with GDP per capita growing at a meager 2.2% per annum between
1970 and 2001. The poor growth performance is largely attributed to a sustained period of
political instability in the country. The problem has been further compounded by the expiry
and nonrenewal of sugar cane land leases, which has reduced the sugar industry’s activities
by around 50% over the last 5 years (Narayan and Narayan, 2004a).
Import payments account for a significant part of Fiji’s income. Over the 1972 to 1999
period, imports accounted for around 54% of real GDP. Like most small developing
countries, Fiji relies heavily on imports of machinery and transport equipment, energy and
manufactured goods to facilitate its economic development. In the last decade, demand for
machinery and transport equipment, energy and manufactured goods, together, have
accounted for 64% of total imports. Strong demand for imports has often led to imbalances
in Fiji’s external accounts; for instance, there have been 22 cases of balance of payment
deficits in the period 1972–1999 (see Fig. 1).

Fig. 1. Fiji’s balance of payment deficits, 1972–1999. Source: calculated from data obtained from the Reserve
Bank of Fiji Quarterly Reviews.
 P.K. Narayan, S. Narayan / Economic Modelling 22 (2005) 423–438 425

Given the importance of imports for Fiji’s economic growth and development, and the
ensuing balance of payments, the aim of this paper is to investigate the determinants of
Fiji’s import demand for the period 1972 to 1999. We confine our empirical tests within
the cointegration and error correction framework so as to derive both long-run and short-
run elasticities. Our study differs from the existing literature on import demand in three
novel ways. First, we study the import demand of a small island economy. Previously an
export demand model has been estimated for Fiji (Narayan and Narayan, 2004b). Here we
construct an import demand model, which we believe will proffer important policy
directions, such as the responsiveness of import demand to changes in income and prices.
Given the importance for policy it is imperative to establish that the results are not
contingent on a particular econometric technique, for if this is the case then the empirical
results are deemed unreliable. In this study, to ascertain the robustness of the long-run
results, we use three different estimators. Here, we use the autoregressive distributed lag
(ARDL) approach advocated by Pesaran and Pesaran (1997), the dynamic ordinary least
squares (DOLS) approach proposed by Stock and Watson (1993) and the Phillips and
Hansen (1990) fully modified (PHFM) ordinary least squares approach.
Second, our study makes a methodological contribution. We use the bounds testing
approach to cointegration, developed by Pesaran et al. (2001), within an autoregressive
distributed lag (ARDL) framework. An important advantage of the ARDL approach is that
it has better small sample properties than the widely used Johansen (1988), Johansen and
Juselius (1990) and the Engel and Granger (1987) approaches in the import demand
literature. Pesaran and Shin (1999)
pffiffishow
ffi that with the ARDL framework, the OLS estimates
of the short-run parameters are T -consistent and the ARDL-based estimates of the long-
run coefficient are consistent in small sample sizes. We also draw upon a new set of critical
values for the bounds F-statistic, which is specific to our sample size, generated by Narayan
(2004a,b). This ensures that our conclusions regarding cointegration are perfect.
Third, we are explicitly concerned about the stability of the long-run import demand,
which has important implications for the validity of the empirical results. Most previous
studies have presumed that the import demand relationship is stable. Whether this is true is
purely an empirical question; hence, there is no reason to believe a priori that the relative
importance of factors influencing the relationship between imports, prices and income has
remained unchanged. To ascertain parameter stability, we apply the Hansen (1992)
stability test.
The structure of the paper is organized as follows. In the next section, we review some
of the literature on import demand models for developing countries. This is followed by an
explanation of the Fiji import demand model and the econometric methodology. In the
penultimate section, we discuss the results and in the final section, we present the
conclusions and policy implications.

2. Literature review

Early studies on developing countries applied either ordinary least squares (OLS) or
two stage least squares (TSLS) techniques to estimate the import demand model (see for
example, Houthakker and Magee, 1969; Khan, 1974, 1975; Goldstein and Khan, 1978,
426 P.K. Narayan, S. Narayan / Economic Modelling 22 (2005) 423–438

1985; Arize and Afifi, 1987). In view of recent developments in econometric techniques,
these studies are suspect because they ignore the time series properties of data. This makes
their results vulnerable to the spurious regression problem for assuming a priori that there
is an equilibrium relationship among the variables in their model. Development of new
tools in dealing with the issues of stationarity and cointegration have enabled researchers
to conduct and offer more reliable statistical inferences about long-run equilibrium and
short-run dynamic relationships between variables, and those related to import demand
models are no exception. Nevertheless, the use of different sample sizes, frequencies of
data, and model/variable specifications produce different results and make the results for
the same countries difficult to compare, as will be seen later. In what follows, we provide a
brief review of some of the recent studies on developing countries conducted within the
cointegration framework.
Bahmani-Oskooee and Niroomand (1998) used the Johansen and Juselius (1990)
technique to estimate import demand models for various countries including some
developing countries (Colombia, Mauritius, South Africa, Tunisia and Philippines). They
used annual data over the period 1960 to 1992. Their results indicate one cointegration
relationship among the import demand variables for all five developing countries. Their
long-run relative price elasticity ranged from !0.53 (South Africa) to !5.48 (Colombia)
while income elasticity ranged from 0.43 (South Africa) to 1.52 (Tunisia). Bahmani-
Oskooee (1998) used similar techniques to estimate the long-run import demand
elasticities, this time using quarterly data (1973–1990), for six countries (Greece, Korea,
Pakistan, Philippines, Singapore and South Africa). He found cointegration relationships
between the variables of the import demand model for all the six countries. Results for
countries which overlapped in the two studies are somewhat different. This difference lies
mostly in the choice of the frequency of data. Long-run results prove to be more reliable
when the length of the sample is higher than with a higher frequency of the sample. Shiller
and Perron (1985) and Hakkio and Rush (1991) contend that increasing the number of
observations by using quarterly or monthly data does not add any robustness to the results
in cointegration analysis because the concern in such analysis is the length of the sample
period.
Sinha (2001) used Phillips-Hansen fully modified ordinary least squares estimator to
examine the standard import demand models for Asian countries including India, Japan,
Sri Lanka and Thailand. He found a cointegration relationship between import volume,
income and relative prices for Japan and Sri Lanka but not for India and Thailand. For Sri
Lanka, he found a negative and statistically significant relationship between import
demand (!0.39) and relative prices (!0.47). He deduced that negative income elasticity
implies that an increase in income leads to an increase in the demand for import
substitutes.
Tang and Mohammod (2000) estimated the standard import demand model for
Malaysia using the Johansen (1988) multivariate cointegration method over the period
1970–1988. They could not find any long-run equilibrium relationship between the
variables. Tang and Nair (2002) re-investigated the Malaysian import demand function
using the bounds testing approach. They found a cointegration relationship between
import volume, relative prices and income. The long-run income and relative price
elasticity were 1.5 and !1.3, respectively.
 P.K. Narayan, S. Narayan / Economic Modelling 22 (2005) 423–438 427

Rijal et al. (2000) estimated a Nepalese import demand function, adopting the split
form of the relative price format together with the income variable using the Johansen and
Juselius (1990) approach to cointegration with data over the 1968–1997 period. Their
results indicated two cointegration relationships between import demand and its
explanatory variables, which included income, domestic prices and import prices. The
long-run income, domestic price and import price elasticities for Nepalese import demand
were 2.13, 0.95 and !0.754, respectively.

3. Import demand model

Recent papers (Sinha, 1997, 2001) have mostly utilised the standard import demand
model to examine import demand behaviour in developing countries. The import demand
model tested here is also a standard one derived within the framework of imperfect
substitution theory. This theory ensures that neither domestic nor foreign goods swallow
up the whole marker when each is produced under constant (or decreasing) costs (Magee,
1975) and that each country is both an importer and exporter of a traded good (Rhomberg,
1973). Moreover, the imperfect substitution model rules out importation of inferior goods.
In what follows, we provide a brief description of the import demand model based on the
imperfect substitution theory.
According to the conventional demand theory, since the consumer is maximising utility
subject to a budget constraint, the demand for imports is expressed as:
MDt ¼ f Yt ; Ptd ; Ptm
" #
- ð1Þ
where demand for real imports is a function of domestic income ( Y t ), prices of domestic
goods and services or cross prices( Pdt ), and prices of imports or own prices ( Pm t ).
Microeconomic theory regards demand functions to be homogenous of degree zero in
prices and money income (Deaton and Muellbauer, 1980). Such a demand function rules
out the presence of money illusion. This implies that if one multiplies all prices and money
income by a positive number, the quantity demanded will remain unchanged. This
involves dividing the right-hand side of Eq. (1) by domestic prices ( Pdt ) (see Goldstein and
Khan, 1985). All the remaining variables are then expressed in logarithmic form to give
_

the following import demand model for Fiji:

lnMt ¼ a0 þ a1 lnYt þ a2 ln RPt þ et ð2Þ
Here at period t, lnM is the natural log of real imports of goods and services; lnY is the
natural log of Fiji’s real gross domestic income; ln RP is the natural log of the relative
price (import price as a proportion of domestic price, where consumer price index (CPI) is
used to proxy domestic price)1. The formulation of prices in relative terms implies two
things. One, domestic and imported goods are imperfect substitutes. Two, it obviates any
collinearity that may occur between price terms or between CPI and domestic income.

1
Due to the unavailability of import price index of Fiji, the MPI is calculated as an index of trading partners’
export price indices (derived from International Financial Statistics, December 2001) weighted by import shares.
428 P.K. Narayan, S. Narayan / Economic Modelling 22 (2005) 423–438

Finally, e t , is the error term bounded with the classical statistical properties.2 To convert
nominal imports into real imports, we use the import price index and to convert nominal
GDP into real GDP, we use the GDP deflator.
The sign on the income coefficient could be either positive or negative. It is positive if
imports are treated like any other good in a consumer’s demand function or if there is no
domestic production of the good so that the import demand function is the demand
function for the good itself (Magee, 1975). However, if the imported good has a relatively
close domestic substitute then it is possible to have a negative relationship between
domestic income and output demand (for a graphical illustration, see Magee, 1975, Fig. 1).
In a recent paper, Sinha (2001) found a negative income elasticity of import demand for
India and Sri Lanka. On the result for India, Sinha (2001, p. 233) noted that bThe negative
income elasticity of demand for imports for India is not very surprising since India has
been producing import substitutes for a long time partly because of the opportunities
created by a very restrictive trade regimeQ. Thus, it follows that the sign on the income
coefficient is a priori indeterminate.
According to demand theory, an increase in import prices reduces demand for imports
as imported goods become more expensive while demand for imported goods increase as
domestic prices increase. Therefore, it is expected that import price relative to domestic
price will be negatively related to real import volumes.
Another basic assumption is that importers are always on their demand schedules such
that demand always equals the actual level of imports. However, it is generally recognized
that imports do not immediately adjust to their long-run equilibrium level following a
change in any of their determinants (Carone, 1996). This may be due to several factors
such as adjustment costs, inertia, and habit or lags in perceiving changes. To capture the
speed of adjustment, we estimate the following error correction model:

=
n
X n
X n
X
DlnMt ¼ b0 þ b1 DlnMt!i þ b2 DlnYt!i þ b3 Dln RPt!i þ b4 et!1 þ lt
i¼1 i¼0 i¼0
ð3Þ
Here, all variables are as previously defined except D which represents change and e t!1
which is the one period lagged error correction term estimated from Eq. (2). The
coefficient on the lagged error correction term measures the speed of adjustment to obtain
equilibrium in the event of shock(s) to the system.
Eqs. (2) and (3) are estimated using annual time series data for the period 1972 to 1999.
The data series are sourced from the World Bank World Tables, IMF International
Financial Statistics Year Book and the Reserve Bank of Fiji Quarterly Reviews.

4. Methodology

We employ the bounds testing procedure developed by Pesaran et al. 1996 (see
Pesaran and Pesaran, 1997; Pesaran and Shin, 1999; Pesaran et al., 2001), within an

2
All the variables are in local currency.
 P.K. Narayan, S. Narayan / Economic Modelling 22 (2005) 423–438 429

autoregressive distributed lag framework (ARDL). This procedure has several

advantages over alternatives such as the Engle and Granger (1987) two-step
residual-based procedure for testing the null of no cointegration and the system-based
reduced rank regression approach pioneered by Johansen (1988, 1995) and Johansen
and Juselius, (1990).3
The first main advantage is that the bounds test approach is applicable irrespective of
whether the underlying regressors are purely I(0), purely I(1) or mutually cointegrated.
Thus, because the bounds test does not depend on pre-testing the order of integration of
the variables, it eliminates the uncertainty associated with pre-testing the order of
integration. Pre-testing is particularly problematic in the unit-root-cointegration literature
where the power of unit root tests are typically low, and there is a switch in the distribution
function of the test statistics as one or more roots of the x t process approach unity (Pesaran
and Pesaran, 1997, p. 184). Second, the unrestricted error correction model (UECM) is
likely to have better statistical properties than the two-step Engle-Granger method because,
unlike the Engle-Granger method the UECM does not push the short-run dynamics into
the residual terms (Banerjee et al., 1993, 1998).
The other major advantage of the bounds test approach is that it can be applied to
studies that have a small sample size. It is well known that the Engle and Granger (1987)
and Johansen (1988, 1995) methods of cointegration are not reliable for small sample
sizes, such as that in the present study. Several previous studies, however, have applied the
bounds test to relatively small sample sizes (see, inter alia, Pattichis, 1999 (20
observations); Narayan and Smyth, 2003a,b (31 observations) and Narayan and Smyth,
2004 (31 observations)).
The ARDL ( p, q 1, q 2,. . .,q k ) model can be written as follows (Pesaran and Pesaran,
1997, pp. 397–399; Pesaran et al., 2001):
k
X
Xð L; pÞyt ¼ a0 þ bi ð L; qi Þxit þ dVwt þ lt ð4Þ
i¼1 x
where

Xð L; pÞ ¼ 1 ! X1 d1 L1 ! X2 d2 L2 ! . . . ! Xp Lp ; ð5Þ

bi ð L; qi Þ ¼ bi0 þ bi1 L þ bi2 L2 þ . . . þ biqi Lqi ; i ¼ 1; 2; . . . ; k; ð6Þ

Here, y t is the dependent variable; a 0 is a constant; L is a lag operator such that Ly t =y t!1;
and w t is an s &1 vector of deterministic variables such as seasonal dummies, time trends,
or exogenous variables with fixed lags. The x it in Eq. (4) is the i independent variable

3
Masih and Masih (2000) argue that although the finding of cointegration should be taken for granted, the
rejection of cointegration should also be thoroughly justified in the light of certain destabilising forces, structural
breaks, and omission of relevant theoretically inferred variables. Evidence of cointegration among variables also
rules out the possibility of the estimated relationship being dspuriousT.
430 P.K. Narayan, S. Narayan / Economic Modelling 22 (2005) 423–438

where i=1,2,. . .,k. In the long run, we have y t =y t!1=. . .=y t!p ; x it =x i,t!1=. . .=x i,t!q where
x i,t!q denotes the qth lag of the ith variable.
The long-run equation with respect to the constant term can be written as follows:
k
X a0
y ¼ a0 þ bi xi þ dVwt þ vt X¼ ð7Þ
i¼1
Xð1; pÞ

The long-run coefficients for a response of y t to a unit change in x it are estimated by:

b̂ i ð1; q̂
b qiÞ b i0 þ b̂
b̂ b i1 þ . . . þ b̂
b iq̂q
bi ¼ ¼ ; i ¼ 1; 2; . . . ; k ð8Þ
X ð1; p̂
X̂ pÞ 1 ! X1 ! X̂ X 2 ! . . . X̂
X p̂p
Here, p̂ and q̂ i , i=1,2,. . .k, are the selected (estimated) values of p and q i , i=1,2,. . .k. The
error correction representation of the ARDL (p̂, q̂ 1,d q̂ 2,. . .,q̂ k ) model can be obtained by
writing Eq. (4) in terms of the lagged levels and the first differences of y t , x 1t , x 2t ,. . .,x kt
and w t :
p̂p!1 k t !1
k q̂qX
XTj Dyt!j þ bTij Dxi;t!j þ dVDwt
X X X
Dyt ¼ Da0 ! bi0 Dxit !
j¼1 i¼1 i¼1 j¼1

! Xð1; p̂
p ÞECMt!1 þ lt ð9Þ

Here, ECMt is the correction term defined by

k
X
ECMt ¼ yt ! â
a! b i xit ! dVwt
b̂
i¼1

and D is the first difference operator; X*, j b*

ij and dV are the coefficients relating to the
short-run dynamics of the model’s convergence to equilibrium while X(1, p̂) measures the
speed of adjustment.
The bounds testing procedure involves two stages. The first stage is to establish
the existence of a long-run relationship. Once a long-run relationship has been
established, a two-step procedure is used in estimating the long-run relationship. An
initial investigation of the existence of a long-run relationship predicted by theory
among the variables in question (see Eqs. (10a) (10b) (10c) below) is preceded by an
estimation of the long-run and short-run parameters using Eqs. (4) and (9), respectively.
Suppose that with respect to Eq. (2), theory predicts that there is a long-run relationship
among ln M t , ln Y t and ln RPt . Without having any prior information about the direction of
the long-run relationship among the variables, the following unrestricted error correction
regressions are estimated (for Eq. (2)), taking each of the variables in turn as a dependent
variable:
n
X n
X n
X
DlnMt ¼ a0M þ biM DlnMt!i þ ciM DlnYt!i þ diM Dln RPt!i
i¼1 i¼0 i¼0

þ k1M lnMt!1 þ k2M lnYt!1 þ k3M ln RPt ! 1 þ e1t ð10aÞ

 P.K. Narayan, S. Narayan / Economic Modelling 22 (2005) 423–438 431

n
X n
X n
X
DlnYt ¼ a0Y þ biY DlnYt!i þ ciY DlnMt!i þ diY Dln RPt!i
i¼1 i¼0 i¼0

þ k1Y lnYt!1 þ k2Y lnMt!1 þ k3Y ln RPt!1 þ e2t ð10bÞ

n
X n
X n
X
Dln RPt ¼ a0RP þ biRP Dln RPt!i þ ciRP DlnYt!i þ diRP DlnMt!i
i¼1 i¼0 i¼0

þ k1RP ln RPt!1 þ k2RP lnYt!1 þ k3RP lnMt!1 þ e3t ð10cÞ

When a long-run relationship exists, the F-test indicates which variable should be
normalised. The null hypothesis for no cointegration among the variables in Eq. (10a)
is (H0: k 1M=k 2M=k 3M=0) denoted by F M (MjY, RP) against the alternative (H0:
k 1Mpk 2Mpk 3Mp0). Similarly, the null hypothesis for testing the dnonexistence of a
long-run relationshipT in Eq. (10b) is denoted by F Y ( YjM, RP); and for Eq. (10c) the F-
test for testing the null hypothesis is denoted by F RP(RPjM, Y).
The F-test has a nonstandard distribution which depends upon; (i) whether variables
included in the ARDL model are I(0) or I(1), (ii) the number of regressors and (iii)
whether the ARDL model contains an intercept and/or a trend. Two sets of critical values
(CVs) are reported in Pesaran and Pesaran (1997) and Pesaran et al. (2001). However,
these CVs are generated for sample sizes of 500 and 1000 observations and 20,000 and
40,000 replications, respectively. Narayan (2004a,b) argues that exiting CVs, because they
are based on large sample sizes, cannot be used for small sample sizes. For instance, he
compares the critical values generated with 31 observations and the critical values reported
in Pesaran et al. (2001) and finds that the upper bound CV at the 5% significance level for
31 observations with four regressors is 4.73 while the corresponding CV for 1000
observations is 3.49, which is 35.5% lower than the CV for 31 observations. Narayan
(2004a,b) generates and reports a new set of CVs for sample sizes ranging from 30 to 80
observations. Given the relatively small sample size in the present study (28 observations),
we extract appropriate CVs from Narayan (2004a).
If the computed F-statistics falls outside the critical bounds, a conclusive decision can
be made regarding cointegration without knowing the order of integration of the
regressors. For instance, if the empirical analysis shows that the estimated F M (d ) is higher
than the upper bound of the critical values then the null hypothesis of no cointegration is
rejected. Once a long-run relationship has been established, in the second stage, a further
two step procedure to estimate the model is carried out. First the orders of the lags in the
ARDL model are selected using the Schwartz Bayesian Criteria (SBC) and in the second
step the selected model is estimated by the ordinary least squares technique. The
methodologies for calculating the long-run elasticities from the DOLS and FHFM are
explained in an appendix to this paper.

5. Empirical results

We start by testing for the presence of long-run relationships. The bounds approach
compares the calculated F-statistics against the critical values generated using stochastic
 432 P.K. Narayan, S. Narayan / Economic Modelling 22 (2005) 423–438

simulations for a sample size of 28 observations with 40,000 replications. For Eq. (10a),
the calculated F-statistic F M (MjY, RP)=8.0401 is higher than the upper bound critical
value of 6.265 at the 1% level (Table 1). Thus, the null hypothesis of no cointegration
cannot be accepted for the import demand model when import volume is the dependent
variable. Notice also that when the other variables [ Y, RP] are taken as dependent variables
the calculated F-statistics are less than the lower bound critical value at the 1% level. This
result indicates that there is a unique cointegration relationship among the variables in
Fiji’s import demand model; and cointegration only exists when import demand is the
dependent variable.
Having found a long-run cointegration relationship, Eq. (2) is estimated using the
following ARDL (n, p, q) specification:
n
X p
X q
X
lnMt ¼ a0 þ a1 lnMt!i þ a2 lnYt!i þ a3 ln RPt!i þ lt ð11Þ
i¼0 i¼0 i¼0

We also estimate the long-run elasticities using the FHFM and DOLS techniques (see
Appendix A for an explanation of the methodologies). This is done to check the robustness
of the results. The results from the long-run model estimated using the ARDL, PHFM and
DOLS techniques are presented in Table 2. Foremost it should be noted that all techniques
provide similar results, implying that our model is not contingent on the econometric
technique applied. Put differently, we can confidently claim that our results are robust.
Among our key results we find that income is a statistically significant determinant of
import volume—a 1% growth in income increases import demand by between 1.5% and
1.9%. This result is not surprising given that Fiji imports a large proportion of raw
materials and capital goods in order to facilitate its export led growth strategy which has
been vigorously pursued since the mid-1980s.
Relative prices (foreign prices as a proportion of domestic prices) have a statistically
significant negative impact on imports. Results from all estimators taken together reveal
that a 1% increase in foreign price relative to domestic price induces approximately 1%
fall in the demand for imports. This means that, other things being equal, an increase in
price is likely to leave the import bill unchanged. This result is statistically significant at
the 1% level.

Table 1
Test for cointegration relationship
Critical value bounds of the F-statistic: intercept and no trend
k 90% level toy .
95% level t . 99% level 1%
I(0) I(1) I(0) I(1) I(0) I(1)
2 2.915 3.695
✓
3.538 4.428
✓
5.155
0 6.265

€①_ ✓ ccointegratin
Calculated F-statistic
F M (MjY, RP)
F Y ( YjM, RP)
8.0401
0.2783
- Edo ask.gs/nrD
F RP(RPjM, Y) 0.2028 ( no integrator
.

-
Critical values are extracted from Narayan (2004a). They are also available in Narayan (2004b).
 P.K. Narayan, S. Narayan / Economic Modelling 22 (2005) 423–438 433

Table 2
Long-run results of Fiji’s import demand
Regressors Coefficients (t-statistics)

0
ARDL
Constant !7.4177 (!1.2382)
ln Y t 1.8891** (2.4737)
ln RPt !1.0644*** (!6.7914)

PHFM
Constant !4.3950 (!1.3780)
ln Y t 1.4927*** (3.6601)
ln RPt !1.0660*** (!11.8804)

DOLS
Constant !7.1612 (!1.8074)
ln Y t 1.8451*** (3.6944)
ln RPt !1.0124*** (!10.4936)
** (***) denotes statistical significance at the 5% (1%) level.

The short-run results and the diagnostic tests are presented in Table 3. In order to test
the reliability of the error correction model, a number of diagnostic tests, including tests of
autocorrelation, normality and heteroscedasticity in the error term, stability and accuracy
of the model, were applied. We found no evidence of autocorrelation in the disturbance of
the error term. The model passes the Jarque-Bera normality test suggesting that the errors
are normally distributed. The RESET test indicates that the model is correctly specified.
Finally, the adjusted R-squared is around 0.65. Hence, it is reasonable to say that the
model is well behaved.
We find that the short-run coefficients on income and relative prices are smaller than
those from the long-run model. Income, however, has a statistically insignificant impact on

Table 3
Short-run results of Fiji’s import demand
Dependent variable: Dln M t
Variables Coefficients t-statistics
Constant !2.8779 !1.0219
Dln Y t 0.7329 1.5434
Dln RPt !0.8590*** !6.0491
ECMt !1 !0.3880** !2.1512

÷÷
Diagnostics Statistics
2
R̄ 0.6509
r 0.0866
v 2Auto(1) 1.0822
v 2Norm(2)
v 2White(1)
womanly 1.1609
0.1013
v 2RESET(1) 0.3835
** (***) denotes statistical significance at the 5% (1%) level.
434 P.K. Narayan, S. Narayan / Economic Modelling 22 (2005) 423–438

Table 4
Hansen test for parameter stability
Tests Test statistic Probability value
LC 0.3121 0.1382
MeanF 0.3411 N0.20
SupF 2.0221 N0.20
ln M t is the dependent variable.
Probability values are in brackets. The test program is available from http//www.ssc.wisc.edu/bhansen/.

import demand. On the other hand, while prices are statistically significant it has an
inelastic impact on import demand.
The error correction term, ECMt!1 is negative and is statistically significant, making
certain that the series is nonexplosive and that long-run equilibrium is attainable. ECMt!1
measures the speed at which import volumes adjust to changes in the explanatory variables
before converging to its equilibrium level and depicts that adjustment in imports does not
occur instantaneously. The coefficient of !0.39 suggests that convergence to equilibrium
after a shock to real imports in Fiji takes slightly over 2 1/2 years.4

5.1. Constancy of cointegration space

The parameter non-constancy tests for I(1) processes advocated by Hansen (1992) was
employed as a check for parameter stability. Hansen (1992) proposes three tests—SupF,
MeanF, and L C—which all have the same null hypothesis but differ in their choice of
alternative hypothesis. The SupF test is predicated on ideas inherent in the classical Chow
F-tests. The alternative hypothesis is a sudden shift in regime at an unknown point in time,
and amounts to calculating the Chow F-statistic. This test statistic takes the following
form: SupF=SupF t/T, where F t/T is the F-test statistic. To perform the SupF test requires
truncation of the sample size T. We follow the approach in Hansen (1992) and use the
subset [0.15T, 0.85T].
The MeanF test is appropriate when the question under investigation is whether or not
the specified model captures a stable relationship (Hansen, 1992). It is computed as an
average of the F t/T. Finally, the L C statistic is recommended if the likelihood of parameter
variation is relatively constant throughout the sample. The test results and their probability
values are reported in Table 4. They show evidence for parameter stability, since the
probability values for each test are greater than 0.05.

6. Conclusions and policy implications

The paper uses a recently developed cointegration technique—the bounds testing

approach—to test for a long-run relationship between import volume, domestic income

4
Tambi (1998) estimates the determinants of capital goods import demand for Cameroon. He finds the
coefficient on the lagged error correction term to be !0.427, implying that with a shock to the system
convergence to equilibrium takes approximately 2.3 years.
 P.K. Narayan, S. Narayan / Economic Modelling 22 (2005) 423–438 435

and relative prices for Fiji. The bounds test reveals that there is one cointegration
relationship between import volume, income and prices when import volume is the
dependent variable. Once we had established cointegration, we used three different long-
run estimators to derive the long-run elasticities. We believe that the use of more than one
estimator is crucial, for it tells whether the results are contingent upon the econometric
technique used. If this is the case then the results are not robust and can have negative
repercussions on policy. To ascertain the robustness of the results, we used the ARDL,
PHFM and DOLS estimators. These three estimators produced broadly consistent results
on the impact of income and relative prices on import volume.
Among our key long-run results, we find that domestic income has a positive impact
on import volumes, while an increase in relative prices reduce imports. On the basis of
these results, pertinent policy implications can be derived. First, it is clear that prices play
an important role in the determination of imports. It should be noted that with a unitary
elasticity on the relative price variable, changes in price would keep Fiji’s import bill
unchanged. While import prices are beyond the control of Fijian policymakers, inflation
can be kept at favorable levels by prudent use of the monetary policies. If inflation in Fiji
was to grow relative to the import price then Fiji’s import bill will increase. In this light,
it is important to highlight that in 2002 Fiji increased value added tax (VAT) from 10% to
12.5%. VAT will induce a rise in inflation; and on the basis of our results, this is likely to
have a negative impact on Fiji’s import bill in the coming years.5
Second, growth in income has a significant and elastic impact on import demand in the
long run. This suggests that higher growth will induce higher demand for imports. If
import growth outweighs export growth, as has been the case in Fiji in most of the years
during the sample period in this study, then balance of payment is likely to deteriorate.
However, as pointed out by one referee of this Journal: ban additional factor is that export-
led growth could also lead to an appreciation of the Fiji dollar, alleviating problems of
balance of payment deficitsQ.
Lastly, it is true that Fiji needs imported raw materials to facilitate growth. However,
the balance of payment problem should not be ignored. In this light, export growth and
diversification, particularly in areas where Fiji has abundance of natural resources such as
fisheries and forestry, is essential. It should be noted that Fiji has not explored the
potential of these sectors due mainly to a sustained period of political instability and
problems with land leases which have absorbed much of the country’s productive
resources.6 It follows, rather obviously, that solutions to Fiji’s internal problems are crucial
for an improvement in the balance of payments.

Acknowledgment

Helpful comments and suggestions by Professor Russell Smyth and an anonymous

referee of this journal on earlier versions of this paper are acknowledged.

5
For an analysis of VAT on Fiji’s economy, see Narayan (2003).
6
In Fiji, political instability has created a massive brain drain, which is hurting investment and economic
growth (for a complete discussion, see Narayan and Smyth, 2003a, 2004).
436 P.K. Narayan, S. Narayan / Economic Modelling 22 (2005) 423–438

Appendix A. DOLS and FHFM estimators

A.1. Dynamic DOLS

The procedure advocated by Stock and Watson (1993) involves estimation of long-run
equilibria via dynamic OLS (DOLS), which corrects for potential simultaneity bias among
regressors. It resembles the ideas inherent in Hansen (1988), Phillips and Loretan (1991),
Phillips and Hansen (1990), Saikkonen (1991), and Park (1992). DOLS entails regressing
one of the I(1) variables on other I(1) variables, the I(0) variables, and lags and leads of the
first difference of the I(1) variables. The essence of incorporating the first difference
variables and the associated lags and leads is to obviate simultaneity bias and small sample
bias inherent among regressors. Standard hypothesis testing can be undertaken using robust
standard errors derived via the procedure recommended by Newey and West (1987).
The DOLS is based on an alternative representation of the system, which assumes the
following particular a priori normalisation, that can be obtained in any system with r
cointegrating vectors:

DX 1t ¼ j1t

X 2t ¼ U0 þ UX 1t þ j1t ðAÞ

where X tV=[X t1VjX t2V], the dimensions of X t1 and X t2 being ( p!r)&1 and (r &1),
respectively. The error processes are deemed stationary and by incorporating both leads
and lags of DX1t in Eq. (A) and estimating the normalised cointegrating vectors, U, by
OLS, one can obtain an estimator asymptotically equivalent to MLE.

A.2. Fully modified OLS (FMOLS)

The procedure, developed by Phillips and Hansen (1990), has two direct advantages.
Apart from correcting for endogeneity and serial correlation effect, it also asymptotically
eliminates the sample bias. There are two conditions considered essential for the
appropriateness of the FMOLS. First, there is only one integrating vector. Second the
explanatory variables are not cointegrated among themselves. Assuming these provisions
are met, the econometric model is of the following form:
yt ¼ r0 þ rV1 X t þ lt ; t ¼ 1; 2; . . . ; n ðBÞ

where y t is an I(1) variable and X t is a (k &1) vector of I(1) regressors, which are not
cointegrated among themselves. By assumption, X t has the following first difference
stationary process:

DX t ¼ g þ kt ; t ¼ 2; 3; . . . ; n ðCÞ

where g is a k &1 vector of drift parameters, k t is a k &1 vector of I(0) variables. It is also
assumed that - t =(l t , kVt ,)Vis strictly stationary with zero mean and a finite positive-definite
covariance matrix, A.
 P.K. Narayan, S. Narayan / Economic Modelling 22 (2005) 423–438 437

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