International trade and economic growth: The nexus, the evidence and the policy

implications for South Africa

Author: Kwame Osei-Assibey

Address: University of Johannesburg
School of Economics APK Campus 2006,
Johannesburg South Africa.
Telephone: +27 (0)115594376
Email: Kwame.osei-assibey@outlook.com

Co-author: Mrs Omolemo Digkang

Address: Monash University South Africa Campus
School of Business and Economics.
144 Peter Road, 1724 Ruimsig, South Africa
Email: omolemojosephs@gmail.com

Abstract:
The trade-growth nexus is revisited for the specific case of South Africa. As an emerging economy,
trade continues to be critical to its economic growth prospects; however, most of the previous
empirical investigation on this ‘well-known’ nexus on South Africa has often focused on testing the
validity of export-led growth hypothesis. We however argue that the ability of imports to stimulate
productivity as well as further economic growth (and consequently a vent-for-surplus gains) cannot
be underestimated: Thus, motivating our application of cointegration analysis based on the Johansen’s
methodology to analyze the dynamic relationship between economic growth, exports and imports.
We observed that, in the long run, export does not only drive economic growth but notably import
growth as well: The positive long-run relationship suggests a healthy sustainable relationship between
export growth and import growth in South Africa. Our empirical evidence however indicates that
controlling for exogenous volatility including volatility in exchange rate and global economic
sentiment is necessary for robust and sustainable long-run equilibrium relationship. Results of
Granger Causality tests based on the estimated VECM compellingly underscores the contributions of
imports to economic growth for South Africa. The significance of our findings and some useful policy
implications are discussed in the paper.

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Key words: Trade-economic growth nexus; Johansen Cointegration test; VECM; Granger Causality; South
Africa.
JEL Codes: F14 ; F43 ; F68 ; C32; O55

1. Introduction
The relationship between economic growth and international trade continues to be a keen area of
research. Empirical studies on this relationship are informed by some complementary and competing
economic theories on the gains from specialization, exchange of goods and services1 and their
consequent impact on economic growth. Although there is an overwhelming empirical support for
the theoretical economic relationship between growth, imports and exports, there still remains some
disagreements on which of the three variable drives the other(s) on a nation’s path to rapid and
sustainable growth. These disagreements continue to inform the mainstream contributions on export-
led growth, growth-led exports and import-led growth strategies. Among these three strategies, there
seem to be a growing consensus2 that export-led growth strategy comparably has the potential to help
developing nations to achieve rapid growth.
As Yang (2008, 3) points out, “export-led growth is considered to mean a case where the
dominant underlying cause of economic growth is an exogenous increase in export activities”. The
importance of an export-led strategy to developing countries is that it aids developing countries to
generate links and integrate into the world economy as production is not limited by the scale of the
domestic economy. In addition, for a developing economy, the export-led strategy may help create a
virtuous cycle where earnings from exports are used to import technological and capital inputs; helping
them to realize the dynamic benefits of specialization and production. Recent experience has however
led some economists to question the positive benefits associated with the export-led strategy. In fact,
Klein and Cukier (2009) take the stance that the era of export-led growth is over in its current form.
They further argued that export-led growth has caused nations (who depend on exports for their real
growth plans) to be exposed to exogenous shocks making them more vulnerable. Critical evidence of
such overdependence has been demonstrated during the recent global recession: Concurrent negative
shocks emanating from developed economies have been observed to cause economic downturns for
emerging economies (such as China and Mexico) that have adopted the export led growth strategy.

1 The theories include Adam Smith’s absolute advantage theory, Ricardian comparative advantage model, Hecksher-
Ohlin’s factor proportion theory and Krugman’s new trade theories.
2 The failure of import substitution industrialization in the 1970s for most developing nations is an important

contributing factor here.

2
 In the face of the changing dynamics of international patterns of trade, any relevant
information on how participation in the global economy affects South Africa’s economic prospects
should be important to policymakers. Our focus on South Africa is not only driven by the country’s
status as an economic powerhouse of Africa (and consequently its importance to the world economy)
but also its efforts through its sustained policies to grow the economy through international trade.
History shows that South Africa’s economy depends heavily foreign trade even during periods where
the economy faced international sanctions. The post-apartheid period however has seen an increased
effort by South Africa to integrate into the international economy. In the past few decades, the world
has observed South Africa developing policies centred at growing the economy through trade
liberalization. Some of the policies include being an important member of, the Southern African
Customs Union (SACU), the Southern African Development Community (SADC), the Trade
Development and Cooperation Agreement (TDCA) the BRICS (Brazil, Russia, India, China, and
South Africa), as well as embarking on the trade policies dedicated at growing its exports through
policies such as the New Growth Path , the National Development Plan-2030, and the Industrial
Policy Action Plan ( Purfield, Farole and Im, 2014). In recent years3, economic growth has been less
robust and as might be expected, policymakers more than ever, sees the trade channel as possessing
the potential to stimulate South Africa’s growth prospects. Expectedly, most of the recent trade
policies and strategies pursued focuses more on export driven economic growth4. Dutt and Ghosh
(1995) however advocates that the export-economic growth causality relationship is economy specific,
and generalization the strategy without considering other factors may not yield the expected outcomes.
Whilst it is very tempting to follow an export-led approach, the potential positive contribution
from imports to growth especially for a developing economy should not be underestimated. In fact,
there is growing evidence that imports growth can stimulate economic growth in developing
economies in many ways including being used as intermediate inputs for further production,
enhancing productivity, as well as serving as channels for the transmission of new ideas and technology
(see, Salvatore [ 2014, 323]. The empirical studies on the trade-growth nexus for South Africa however
have mainly focused on the relationship between economic growth and exports (Ukpolo 1998;
Ziramba 2011). Our study is motivated by the above arguments. as well the almost non-existence of
a thorough empirical assessment on the impact of import growth to economic growth and

3Annual real growth for the past decade (2008-2018) averaged 1.5%.
4A case in point is the Integrated National Export Strategy (INES) launched in March 2016 by the South African
Department of Trade and Industry (DTI). The policy aims to attain a 6%-a-year export growth target by 2030.

3
consequently export growth: Empirical evidence on short and the long run contributions of imports
to the trade-economic growth nexus can be exploited by policymakers to the benefit of the South
African economy.
Thus, to enable us reach correct conclusions5 about the relationships between growth, export
and import, we first examined the existence of a long-run relationship using the Johansen
cointegration methodology. A VECM that describes the adjustments (from temporary shocks) to the
established long-run equilibrium relationship among the variables is estimated. Granger Causality tests
based on the estimated VECM was used to analyze the short-run dynamics between the variables. We
ensured our regression estimates were free from inferential and small sample biases by using available
quarterly data from 1960:1 to 2018:1 (Caballero, 1994; Johansen, 2002). We further controlled for
exogenous events6 using a combination of outliers’ dummies and proxies for volatilities in the South
African rand and global economy sentiment and consequently achieved robust estimation. The
existence of a cointegration however implies that an exogenous shock to any of the variables would
not result in a permanent destabilization in the long-run relationship between them. Our empirical
evidence is a very significant one when compared to previous empirical studies that did not pay
particular attention to the importance of imports in the analyses of the trade-economic growth nexus
The rest of the paper is organized as follows: Section 2 presents a discussion on the economic
theories and review of the related previous empirical studies that motivated our study; in Section 3,
we present the data, and the empirical framework; Section 4 discusses our findings and finally Section
5 concludes this paper.

2. A Review of Theoretical and Empirical Literature

In this section, we first present the bases for our current study by presenting a narrative on theories
and mainstream contributions that supports the relationships between exports, imports and economic
growth. This is then followed by a critical evaluation of the empirical studies and how their
contributions are linked to our study

2.1 Theories Supporting the Relationship between International Trade and Economic
Growth

5 For example of robust causality test procedure in the presence of cointegration (see, Bahmani-Oskooee and Alse
[199]).
6
See Saikkonen and Lütkepohl (2000) on how to deal with structural breaks in cointegrating analysis.

4
The Heckscher–Ohlin’s (H-O) theory is arguably the main theory that describes the relationship
between international trade and economic growth (both export-led and import-led) leading it to serve
as the theoretical basis for most of the empirical work in this area. The theory uses a two nations, two
products and two factors general equilibrium model7 supported by other assumptions to show that
nations’ relative factor endowment and the proportions which the factors are used (relatively) in
production determines the basis and pattern of specialization and exchange. Under the H-O
framework, it can be demonstrated analytically that free trade positively impacts aggregate efficiencies
(exports and imports) well beyond pre-trade optimum levels. The further consequence of trade on
economic growth from the H-O framework are further explained by four major theorems namely the
Stolper-Samuelson theorem (that explains the returns to factor price due to free trade); the Factor
Price Equalization theorem (that explains the equalization of prices under a free trade setting); the
Rybczynski theorem (which accommodates the implications of factor growth under the H-O
framework) ; and the Aggregate Economic Efficiency theorem ( which explains welfare increases as a
result of production and consumption efficiencies due to specialization and exchanging) .
On the impact of economic growth on exports (growth led exports), Schumpeter’s economic
growth model proposes that a country’s economy can be driven endogenously, through technological
innovations that result in new product innovations, new production activities and new products . This
endogenous growth can help accelerate the growth of the economy, consequently leading to excess
supply and increased exports. There is also a wide support for the impact of imports on economic
growth (import-led growth). This is especially true if intermediate manufactures and capital goods
imports are used as inputs for exports production In addition, imports can drive economic growth
since imports are embodied with foreign research and development and the spillovers to domestic
workers over time may result in increased productivity (see, e.g., Mazumdar [2002]). Other mainstream
contributions suggest a virtuous cycle between economic growth and international trade. An increase
in economic activity can positively affect imports of inputs that are used for export production. This
subsequently stimulate further growth (via the growth in exports). As further emphasized by
Grossman and Helpman, (1991a) and Frankel and Romer (1999), trade profoundly influences
economic growth of a country and that the growth rates of economies that pursue liberalized trade
regimes are greater than those of closed economies. This view is supported by studies including the
World Bank (1993) findings on East Asian economies which concluded that countries that increase

7 Vanek (1968) advanced the original H-O model to allow for the application to a world of many goods and factors.

5
their participation in international trade achieve long-term economic growth faster than countries that
are less open to global trade.
Expectedly, the theories and contributions on the nature of the relationship between economic
growth and international trade have helped to actively spur the empirical assessment on this subject.
We present a review on some of the empirical findings in the next sub-section.
2.2 Empirical Literature Review
Unsurprisingly, the field of empirical examination to test the theoretical relationship between
international trade and economic growth continue to be one of the most active in economics. One
major reason why this relationship continues to be one of the most empirically researched area is
because countries continuously seek to implement well informed growth policies that will help them
to continuously reap both the static and dynamic benefits of trade. For simplicity, we present the
review of previous empirical studies on South Africa separately from those from the rest of the world.
In this way, we relate how our current work on South Africa relates to the gaps identified in the
previous literature on both South African and other countries’ studies.
2.2.1 Empirical Evidence from Studies on South Africa
Interest on the impact of international trade on economic growth in South Africa has seen an increase
in the post-apartheid era as the country continue to increase its integration into the international
economy. Consequently, interest in the field of empirical exploration on the relationship (between
trade and growth) continues to grow. The empirical evidence is growing, however, most of the
empirical work that provide these evidence focused mostly on the relationship between export and
growth. Using data from 1964 and 1993, Ukpolo (1998) applied the Johansen cointegration technique
to investigate the long-run relationship between South Africa’s exports and economic growth and
observed that exports and growth are cointegrated; thus confirming the existence of a long-run
relationship. In addition, Ukpolo (1988) observed that economic growth Granger-causes export
growth (growth led exports) with no evidence on existence of a reversed Granger-causal relationship
(export led growth). With a relatively larger sample size between 1960 and 2008, Ziramba (2011) used
the Toda and Yamamoto (1995) technique of Granger causality test to analyse how different
components of South Africa’s major exports (namely merchandise exports, gold and service exports)
affects real GDP. The study concluded that there is causal relationship from merchandise exports to
economic growth and concludes that there is evidence of export led growth.
Ajimi, Aye, Balcilar and Gupta (2015) attempted a much more extended approach to analyse
the relationship between growth and exports for the period between 1911 and 2011 by applying two

6
non-linear Granger causality testing techniques and a linear causality but observed mixed findings:
The linear Granger causality test produced no evidence of causal relationship. The non-linear Granger
causality test based on Hiemstra and Jones (1994) produced evidence of a unidirectional causal impact
from GDP to exports whereas the one based on Diks and Panchenko (2006) produced evidence of a
bidirectional relationship. Gossel and Biekpe (2013) investigated the causal relationship between trade
growth and economic growth, controlling for the effects of capital flows in post-apartheid South
Africa (specifically from 1995 to 2011). The study observed that although trade plays a significant
important role on economic growth, exports actually plays a more significant role compared to
imports. The drawback of this study is that they only focused on a shorter period compared with our
current study, excluding apartheid period where South Africa experimented with import substitution
policy.

2.2.2 Empirical Evidence on other Countries

Beyond South Africa, there is vast literature on the relationship of international trade and economic
growth.
Earlier empirical studies that provided support for the export led growth (export led growth)
hypothesis included Michaely (1977) who employed a correlation analyses on a cross-sectional data of
twenty-three countries between 1960 and 1973 and concluded that growth in exports positively affect
economic growth. The validity of Michaely (1977) findings were however criticized on many grounds.
One of such criticism was his use of cross-sectional data as it is argued that the framework does not
provide useful country specific information to policymakers (Medina-Smith 2000). Aside the major
criticism offered by Medina-Smith (2000), Shirazi and Manap (2003) argues that a cross-sectional
framework is not an effective tool, particularly when applied to assess the relationship between trade
and growth, since this relationship is dynamic and is expected to change with time. Thus evidence of
existence of export led growth based on a cross-sectional framework may not be robust. Sengupta
(1991) applied cointegration technique to data between 1967 and 1986 to the specific country case of
South Korea and observed evidence of export led growth. Further time series studies that support the
export led growth hypothesis include Shirazi and Manap (2003). In contrast, studies including
Henriques and Sadorsky (1996) applied time series techniques including error correction model and
cointegration analysis but observed no evidence of export-led growth hypothesis in some countries.

7
 Empirical studies on the import led growth and the growth led export hypotheses are rather
few compared to studies on export led growth hypothesis. Notable contributions to the import led
growth hypothesis include Thangavelu and Rajaguru (2004) and Awokuse (2008) while Henriques and
Sardosky (1996) and Chen (2007) studies provide evidence on the growth led export hypothesis.
Thangavelu and Rajaguru (2004) examined this hypothesis using a vector error correction model
(VECM) framework on nine important Asian economies and observed that imports was important
to output growth compared to exports. Awokuse (2008) examined the nature of relationship between
trade variables and economic growth for Argentina, Colombia and Peru using Granger causality tests
and impulse response functions. The study observed that imports played a significant role to economic
growth in these three economies. In addition, Awokuse (2008) also observed instances of reverse
causality from growth to both exports and imports. On growth led export evidence, Henriques and
Sadorsky (1996) examined Granger causality among Canadian exports, terms of trade and GDP
through a vector auto regression (VAR) framework and observed that export growth causes GDP
growth. Chen (2007) on the other hand examined the Granger causal relationship between GDP,
exports, terms of trade and labour productivity in a VECM and an autoregressive distributive lag
(ARDL) framework and observed a bi-directional causal relationship between exports and GDP
(evidence of growth led export and export led growth).
2.2.3. How does Previous Empirical Studies inform our Current Work?
We identified major issues from the empirical literature that we believed when addressed, should
contribute to the existing knowledge on the nature of relationship between economic growth and
international trade.
Firstly, most of the literature reviewed on South Africa excluded imports8 in their analysis. As
already mentioned, growth in imports can also induce growth in the export side of the economy and
allow the country to become competitive (import-led growth). In addition, studies including Chen
(2007) and Awokose (2008) suggest reversed causality between growth, exports and imports, it should
be interesting to test for existence of a virtuous cycle among these three variables. Understanding of
the nature of dynamic relationship that exists between economic growth, exports and imports in South
Africa should not only contribute to our existing knowledge but also be useful to policymakers in
recommending policies that would enhance the country’s competitiveness. Secondly, unlike other

8Lawrence and Weinstein (1999) argues that countries which experiences fast export growth also experience fast import
growth. Thus an empirical investigation on the relationship between exports and growth may actually suffer from
omitted variable problem

8
studies, our current attempt considers a relatively large number of observations by using quarterly
data9 instead of annual data. Some of the previous studies used data that are collected over shorter
time periods within a long-run equilibrium framework (see, e.g., Gossel and Biekpe [2013]. It is widely
accepted in time series empirical analysis that a regression based on smaller number of observations
can potentially suffer from non-normal distribution problems and time period bias which could
introduce inferential bias. A larger data size should be sufficient and representative to provide us the
desired statistics which would enable us to provide a much more informed probability statements
about the population. Finally, for any long-run economic analysis, it is almost certain to observe short-
run exogenous events causing short-run fluctuations around the general long-run trending pattern of
the historical data of the variables under consideration. Such exogenous shocks if significant, can
introduce heteroscedastic and other non-normality issues into a regression analysis. Our work ensured
robustness of estimates by controlling for such significant exogenous events. The next section
presents the data and the empirical frameworks used in this study.
3. Data, Conceptual and Empirical Framework
In this section, we first presents a brief graphical and correlation analyses between the variables.
This is followed by a discussion on the conceptual framework as well as the empirical framework
used in our study.
3.1. The Data
Figure One: South Africa’s Quarterly GDP, Exports and Imports (1960-2018)
GDP EXP IMP
28 28 28

26 26
26

24 24
24
22 22

22
20 20

20 18 18
60 65 70 75 80 85 90 95 00 05 10 15 60 65 70 75 80 85 90 95 00 05 10 15 60 65 70 75 80 85 90 95 00 05 10 15

Table One: Pearson’s Correlation Coefficient

Variable GDP EXP IMP
GDP 1.00
EXP 0.93 1.00
[17.73]***

9Zhou (2001) study emphasizes the benefits of high frequency data to power and robustness of cointegration tests
especially when studies are restricted by short-time spans.

9
 IMP 0.94 0.96 1.00
[19.11]*** [26.34]***

T-statistics in parenthesis. ***, ** and * indicate significance at 1%, 5% and 10% respectively
The historical quarterly data on South Africa’s GDP, imports and exports (all in current US dollars)
were obtained from the OECD database. The period of study covers the first quarter of 1960 to the
first quarter of 2018. A graphical presentation of the logarithm transformed series is presented in
Figure One10. Casual analysis suggests exports and imports appear to be affected by exogenous events
compared to GDP. We can also infer from the graphs that the trade variables appears to be more
affected by shocks compared to GDP with imports appearing to exhibit more fluctuations than
exports. All three variables similarly exhibit a general positive linear trend for the period of interest.
The very high correlation values (Table One) further underscores strong and statistical significant
linear relationship between variables pairs. However, the pair-wise correlation does not inform us
about the causal and long-run relationship among the three variables. Consequently, we proceed to
develop the appropriate framework that allows us to test both the strength and direction of
relationship as well as the implied causal effects and the dynamic long-run relationship among the
variables.
3.2 Conceptual and Empirical Framework
As previously discussed, our main objective is to understand the nature of dynamic relationship among
GDP, exports and imports in the South African context. Based on the theoretical, empirical and
mainstream contributions discussed we pre-identified the following long-run and short run
possibilities;
1. Unilateral causality from one variable to another.
2. Bidirectional causality between variable pairs.
3. Joint causality running from any selected variable pair to a third variable.

Given the listed causal relationships possibilities, one may be tempted analyse the relationship
between the variables by running three different estimations based on the ‘naïve' model similar to
Equation 111 as follows

𝑦1𝑡 = 𝛽0 + 𝛽1 𝑦2𝑡 + 𝛽2 𝑦3𝑡 + 𝜖𝑡 (1)

10EXP and IMP represent exports and imports respectively.

11 For each estimation, if any of the three variables say 𝑦1 is considered the dependent variable then the remaining two
variables enters the model as independent variables represented by 𝑦2 and 𝑦3 .

10
The likely consequence of such estimations is the spurious regression problem12 (see, Granger and
Newbold [1974]; Phillips [1986a]: Even if theory suggest the existence of some relationship between
some 𝑦1 (dependent variable) and 𝑦2 / 𝑦3 (as independent variables), their similar trended nature
could be suggestive of a long-run relationship between the variables in levels. Thus rather than
examining the relationships between the variables using three separated ‘naïve’ multiple linear
regression equations of each variable. We proceed to investigate the existence of cointegration and
short-run dynamics, and consequently, examine the adjustment processes of deviations from an
established long-run equilibrium.

3.2.1 Identification of the Order of Integration of the Variables

Key to estimating a meaningful (i.e. one that makes both economic and econometric sense) dynamic
long-run relationship among the variables is the identification of their order of integration. Even
without reference to the underlying data generating process), we can observe different mean and trend
levels in each variable (See Figure One), suggesting some evidence of mean non-stationarity.
To formally test for stationarity we used the Augmented Dickey Fuller test (ADF) based on test
regression similar to Equation 2 below:
𝑝
∆𝑌𝑡 = 𝛽0 + 𝜑𝑌𝑡−1 + ∑𝑡=1 ∆𝑌𝑡−1 + 𝜀𝑡 (2)
Where our coefficient of interest is 𝜑. The null hypothesis of existence of a unit root is rejected if
the calculated ADF t-statistics is smaller than the critical values from the DF table.

3.2.2 Cointegration and the Long-run Equilibrium Relationship

The intuition underlying the implementation of the cointegration framework in our study is to analyze
whether the similar trending nature in GDP, exports and imports does not occur by chance but
actually reflects a long-run relationship among them. Thus although our variables of interest may be
integrated to the same order, if there exists some linear combination of these variables (in levels) that
result in a stationary process, then the variables are cointegrated. In essence, if the variables are
cointegrated, then any shock to any of the variables should not cause the variable to permanently drift
away from equilibrium and subsequently affect their existing long-run relationship. Conversely
adjustment to long-run equilibrium would not occur if no linear combination of the variables results

12Actual regression estimates (provided upon request) using the data on GDP, exports and imports for South Africa
produced extremely high R-square values and corresponding low Durbin Watson (DW) statistics as expected

11
in a stationary process. In such a situation, although correlation and regression analysis may suggest
some relationship, such a relationship may be short-run or spurious since shocks can result in the
variables permanently drifting away from the previously observed (similar) trend with the other
variables.
Let 𝑌𝑡 = (𝑦1𝑡 , 𝑦2𝑡 , 𝑦3𝑡 )′ (3)

represents a vector of our variables of interest. For the variables to be cointegrated, then there should
exist a vector (cointegrating vector)

β = (𝛽1 , 𝛽2 , 𝛽3 )′ such that

𝛽 ′ 𝑌𝑡 = 𝛽1 𝑦1𝑡 + 𝛽2 𝑦2𝑡 + 𝛽3 𝑦3𝑡 ∼ 𝐼(0) (4)

Let 𝛽1 𝑦1𝑡 − 𝛽2 𝑦2𝑡 − 𝛽3 𝑦3𝑡 = 𝜀𝑡

Then, 𝛽 ′ 𝑌𝑡 = 𝜀𝑡 (5)

Thus, 𝜀𝑡 ~𝐼(0) is the cointegrating residual. A non-zero 𝜀𝑡 represents the short-run deviation from
the long-run equilibrium; in the long-run 𝜀𝑡 = 0.

It is evident from Equation 5 that a cointegrating vector may not necessarily be unique since
by multiplying both sides of the equation by a non-zero scaler, the equivalence is not affected. Thus,
one need to use a normalization assumption to uniquely identify 𝛽. As an illustration, a commonly
used normalization is to specify one variable as the dependent variables, and the others as independent
variables as presented in Equation 6 below:
𝛽 = (1, −𝛽2, −𝛽3 ) (6)

Then together with Equation 4, we obtain

𝛽 ′ 𝑌𝑡 = 𝑦1𝑡 − 𝛽2 𝑦2𝑡 − 𝛽3 𝑦3𝑡 ~𝐼(0) (7)

And

𝑦1𝑡 = 𝛽2 𝑦2𝑡 + 𝛽3 𝑦3𝑡 + 𝜀𝑡 ; 𝜀𝑡 ~𝐼(0) - the cointegrating residual. (8)

𝜀𝑡 = 0 in the long-run, thus rendering the long-run relationship to become 𝑦1𝑡 = 𝛽2 𝑦2𝑡 + 𝛽3 𝑦3𝑡 .
Thus 𝜀𝑡 is of utmost importance in describing the relationship between the short-run and long-run
dynamics between the variables. An error correction model (ECM) is the technique used to analyse
this dynamic relationship. We present this framework later in section 3.2.4.

12
3.2.3 Testing for Cointegration
We applied the Johansen cointegration technique (Johansen 1988 & Johansen and Juselius 1990) since
it is arguably the best framework for testing the existence of cointegration relationship(s) in a
multivariable regression analysis. A k-variable VAR model set-up of the variables (with the intercept
and other exogenous intentionally omitted for simplicity) in levels (in vector-matrix notation) of the
form in equation 9 is used for our cointegration test:
𝑝

𝑌𝑡 = ∑ Γ𝑖 𝑌𝑡−𝑖 + 𝜖𝑡 (9)
𝑖=1

Where 𝑌𝑡 represents a 𝑘 × 1 vector of variables; Γ𝑖 ′𝑠 are 𝑘 × 𝑘 coefficients matrix.; 𝜖𝑡 are serially

correlated random vectors assumed to have the following characteristics:𝐸(𝜖𝑡 ) = 0; 𝐸(𝜖𝑡 ′𝜖𝑡−𝑠 ) = 0
for all 𝑠 ≠ 0 (i.e. no correlation within equations but correlation across the system of equations
exists- 𝐸(𝜖𝑡 ′𝜖𝑡 ) = Ω).

In this paper, we used both the trace and the maximum Eigenvalue tests to determine the
cointegrating relationship(s) among the variables. These are likelihood ratio (LR) tests13 calculated
using the eigenvalues14 (𝜆𝑖 ) of the long-run impact matrix (Π ). The knowledge of the rank of Π (the
long-run impact matrix) is important in the determination of cointegration relationships among
variables under the Johansen method. The calculated eigenvalues for Π are used to determine its rank.
The test hypothesis for trace test, is formulated as follows;
𝐻0 : 𝑟𝑎𝑛𝑘(Π) = 𝑟0 against the alternative 𝐻1 : 𝑟0 < 𝑟𝑎𝑛𝑘(𝛱) ≤ 𝑘
The likelihood ratio for the test is calculated as 𝐿𝑅(𝑟0 ) = −(𝑇) ∑𝑘𝑖=𝑟+1 ln(1 − 𝜆̂𝑖 ); where 𝑇
represents the number of observations that are used to estimate the VAR. If the null hypothesis of
𝑟0 = 0 is not rejected, then there is no cointegrating vector among the 𝑘 variables. However if we
fail to reject the null hypothesis then the rank of Π exists between 1 and 𝑘 and the test reformulated
with the null hypothesis being 𝑟0 = 1 and the alternative in the being 1 < 𝑟𝑎𝑛𝑘(𝛱) ≤ 𝑘: In this case
if we fail to reject the null, then there exists exactly one cointegrating vector among the 𝑘 variables.
Otherwise, then there exists at least two cointegrating vectors. The sequential testing procedure is
continued until we fail to reject a sequential reformulated null hypothesis.

13 See Johansen (1995) for critical values for the trace and maximum eigenvalue cointegration tests.

14 The eigenvalues are calculated as the adjusted square of the canonical correlations between ∆𝑌𝑡 and 𝑌𝑡−1 ; with 0 ≤
𝜆̂𝑖 ≤ 1.

13
 The test hypothesis for the maximum eigenvalue test is formulated as;
𝐻0 : 𝑟𝑎𝑛𝑘(Π) = 𝑟0 against the alternative 𝐻1 : 𝑟𝑎𝑛𝑘(𝛱) = 𝑟0 + 1 .
The sequential procedural test is similar to the trace test but the test is based on the largest eigenvalue.
If we fail to reject the null hypothesis of 𝑟0 = 0 , then rank of 𝛱 = 0 ( the largest eigenvalue is zero),
implying no cointegrating vector among the variables. However, if we reject the null hypothesis in
favour of the alternative 𝑟0 = 1 then the largest eigenvalue is not equal to zero. This suggests that
the𝑟𝑎𝑛𝑘(𝛱) ≥ 1, and it implies the existence of at least one cointegrating vector. The sequential test
is continued to determine if the second largest eigenvalue equals zero: If this is true, then the rank of
𝛱 is exactly equal to one and hence there exist one cointegrating vector. If however the second largest
eigenvalue is not equal to zero, then it suggests the existence of more than one cointegrating vector.
The sequential testing procedure is continued until we fail to reject null hypothesis of a zero
eigenvalue. The likelihood ratio for the maximum eigenvalue test, calculated as; 𝐿𝑅𝑚𝑎𝑥 (𝑟0 ) =
−(𝑇)𝑙𝑛(1 − 𝜆̂𝑟0 +1 ).
The cointegration test is sensitive to the choice of the VAR’s lag length used (see, Stock and
Watson [1993] on this). In econometrics practice however, obtaining the optimum lag length for a
VAR system is in a way some sort of a ‘balancing act’- An adequate and sufficient lag length should
be free from the extremities of overfitting/under fitting and more importantly from autocorrelation
(Hendry and Juselius, 2001). We took a more objective approach in our lag-selection process; we did
not select lags based on any pre-specified criterion as done in other studies but rather compared
optimum lag lengths as suggested by five of the most applied lag selection criteria applied in the
literature. In the case of different criteria suggesting different optimum lag choice we choose the lag
that make both practical and economic sense. The five lag selection criteria used were;
2 𝑇+𝑘𝑝+1 𝑘 2ln{𝑙𝑛𝑇}
𝑨𝑰𝑪 (𝒑) = 𝑙𝑛|∑(𝑝)| + (𝑘 2 𝑝); 𝑭𝑷𝑬(𝒑) = |∑(𝑝)| ( ) ; 𝑯𝑸𝑪 (𝒑) = 𝑙𝑛|∑(𝑝)| + (𝑘 2 𝑝) ;
𝑇 𝑇−𝑘𝑝−1 𝑇

𝑙𝑛𝑇
𝑳𝑹 (𝒑) = (𝑇 − 𝑘)(𝑙𝑛|∑(𝑝)| − 𝑙𝑛|∑(𝑝 + 1)|) ; 𝑺𝑪 (𝒑) = 𝑙𝑛|∑(𝑝)| + (𝑘 2 𝑝)
𝑇

Where AIC, FPE, HQC, LR and SIC are respectively Akaike information criterion, final prediction
error, Hannan-Quin criterion, likelihood ratio (sequential), and Schwartz criterion. ∑(𝑝) is the
maximum likelihood estimate of the innovation covariance matrix of the 𝑉𝐴𝑅(𝑝). For the AIC, FPE,
HQC and the SC, the estimated optimum selected lag 𝑝̂ (of the process true lag) is the one that
minimizes the criterion function. For The sequential LR test, if VAR (p) [i.e. the process with the

14
shorter number of lags] is the true model, then the null hypothesis formulated below should also be
true:
2
𝐻0 : Φ𝑝+𝑛 = 𝛷𝑝+𝑛−1 = ⋯ = 𝛷𝑝+2 = 𝛷𝑝+1 = 0 . The Sequential LR test is 𝜒(𝑘 2)

3.2.4 Cointegration and the VECM

The following possibilities can be deduced from discussions on the trace and maximum eigenvalue
tests: (1) If 𝑟𝑎𝑛𝑘 (Π) = 0 ⟹ Π = 0. In this case, 𝑌𝑡 is a nonstationary process but not cointegrated.
If it is an 𝐼(1) process, a first difference transformation of variables eliminates nonstationary. Thus a
𝑉𝐴𝑅 representation of the variables in first difference should be used; (2) the case where 𝑟𝑎𝑛𝑘 (Π) =
𝑟 = 𝑘 or Π has a full rank. This implies that variables are stationary. Thus VAR representations of the
variables should be used; (3) the special case of interest where 0 < 𝑟𝑎𝑛𝑘(Π) = 𝑟 < 𝑘. In this case
𝑌𝑡 is nonstationary and cointegrated15. A VECM is the recommended technique to estimate
cointegrated variables. Thus, upon detection of cointegration relationship(s) a VECM similar to the
form in Equation 1016 should be estimated to describe how the variables adjusts to long-run
equilibrium from transitory shocks.
𝑝−1

∆𝑌𝑡 = Π𝑌𝑡−1 + ∑ Γ𝑖∗ ∆𝑌𝑡−𝑖 + 𝜖𝑡 (10)

𝑖=1
𝑝 𝑝

Where, Π = ∑ Γ𝑗 − 𝐼 and 𝛤𝑖∗ = − ∑ 𝛤𝑗 and ΠYt−1 is the lagged error correction term.
𝑗=1 𝑗=𝑖+1

For a study involving three variables (as in our present case) Equation 10 can be partitioned as follows;
∆𝑦1𝑡 Π11 Π12 Π13 𝑦1𝑡−1 Γ11,i Γ12,i Γ13,i ∆𝑦1𝑡−𝑖 𝜖1𝑡
𝑝−1
[∆𝑦2𝑡 ] = [Π21 Π22 Π23 ] [𝑦2𝑡−1 ] + ∑𝑖=1 [Γ21,i Γ22,i Γ23,i ] [∆𝑦2𝑡−𝑖 ] + [𝜖2𝑡 ] (11)
∆𝑦3𝑡 Π31 Π32 Π33 𝑦3𝑡−1 Γ31,i Γ32,i Γ33,i ∆𝑦3𝑡−𝑖 𝜖3𝑡

Π consists of two matrices namely; a matrix of adjustment parameter (𝛼) and a matrix of
cointegrating vectors (𝛽) thus the following;
𝑝−1

∆𝑌𝑡 = α(𝛽 𝑌𝑡−1 ) + ∑ Γ𝑖∗ ∆𝑌𝑡−𝑖 + 𝜖𝑡

′ (12)
𝑖=1

15 (1) There are 𝑘 𝐼(1) variable (2) There are 𝑟 linear combinations which are stationary; that is 𝑟 rows of cointegrating
vectors in 𝛽 ′ (3)There are 𝑟 cointegrating relations and 𝑘 − 𝑟 unit roots. Also, If we have k variables the maximum
cointegrating vectors that can exists should be k-1.
16In fact, it can be shown that the for lags 𝑝 > 1, the VAR model in in levels (Equation 9) can also be expressed as a

VECM (Equation 10) without any loss of information.

15
Since 𝑌𝑡 is an 𝐼(1) process, ∆𝑌𝑡 (on the RHS), and its lags as well 𝜖𝑡 (on the LHS) should be a
stationary processes. But since 𝑌𝑡 is an 𝐼(1) process, its lag 𝑌𝑡−1 is also expected to be an 𝐼(1)
processes. Thus for the linear combination of 𝛽 ′ 𝑌𝑡−1 to be an 𝐼(0) process, then 𝛽 ′ should contain
the cointegrating vector (see section 3.2.2); actually the rows of 𝛽 ′ forms the basis of the cointegrating
vectors. We observed from Equation 5 that the linear combination of 𝛽 ′ 𝑌𝑡 could result in a short-run
deviation (𝜀𝑡 ≠ 0) or a long-run equilibrium (𝜀𝑡 = 0). 𝛽 ′ 𝑌𝑡−1 may result in a short-run deviation since
the long-run equilibrium may not necessarily hold at 𝑡𝑖𝑚𝑒 = 𝑡 − 1. Thus in the VECM set-up, the
adjustment parameter (𝛼) together with 𝛽 ′ 𝑌𝑡−1 help with the adjustment process of ∆𝑌𝑡 in the
presence of temporary shocks to the system in equilibrium. The coefficients Γ𝑖∗ reflects the short run
changes captured by the changes in the lags of the variables.
Since the VECM is a time series model derived from the autoregressive model (which is weakly
dependent time series process), it should be ensured that the estimated model does not suffer from
autocorrelation (in addition to the residuals being weakly stationary). Also residuals should be
normally distributed since the identification of the number of cointegration equations under the
Johansen’s framework are based on maximum likelihood. In addition, variance of the error term
should be homoscedastic. Finally, an estimated VECM should also pass the stability test; a VECM is
said to be stable if the VAR inverse roots of its characteristics polynomial 17are less than unity.
3.2.5 Granger Causality / Block Exogeneity Test
Since the Granger causality test is short-run test, usually a VAR estimations of the variables in their
first difference is used. However, in the presence of a cointegration relationship, it is advisable to apply
the test on the estimated VECM regression model (see Granger [1988]). As an illustration (using
Equation 11), a test to assess whether 𝑦2𝑡 Granger causes 𝑦1𝑡 will be based on the following joint
restriction hypothesis;
𝑦 ↛𝑦1𝑡
𝐻0 2𝑡 : 𝛤12,𝑖 = 0 (i.e. 𝑦2𝑡 does not Granger cause 𝑦1𝑡 ) versus
𝑦 ⟶𝑦1𝑡
𝐻1 2𝑡 : 𝛤12,𝑖 ≠ 0 (i.e. 𝑦2𝑡 Granger cause 𝑦1𝑡 )
The test follows a 𝜒 2 distribution with p-degrees of freedom. A rejection of the null hypothesis
means 𝑦2𝑡 Granger causes 𝑦1𝑡 . Note that 𝑦2𝑡 Granger causing 𝑦1𝑡 does not necessarily mean the
reverse also holds; for the reverse to hold, a rejection of the null hypothesis below (implies that 𝑦1𝑡
Granger causes 𝑦2𝑡 -

17 The characteristics roots are the values of 𝑧 that solves polynomial equation |Ι − Γ1 𝑧1 − Γ2 𝑧 2 … − Γ𝑝 𝑧 𝑝 | = 0

16
 𝑦 ↛𝑦2𝑡
𝐻0 1𝑡 : 𝛤21,𝑖 = 0 (i.e 𝑦1𝑡 does not Granger cause 𝑦2𝑡 )
A bi-directional causal relationship exists if 𝑦2𝑡 Granger causes 𝑦1𝑡 , and 𝑦1𝑡 Granger causes 𝑦2𝑡 . A
three-variable system (like in our case) also allows us to test for block exogeneity18. As an example, the
rejection of the null hypothesis below implies that both 𝑦1𝑡 and 𝑦2𝑡 jointly Granger causes 𝑦3𝑡 -
𝑦 𝑦2𝑡 ↛𝑦3𝑡
𝐻0 1𝑡, : 𝛤31,𝑖 = 𝛤32,𝑖 = 0 (i.e. both 𝑦1𝑡 and 𝑦2𝑡 does not jointly Granger cause 𝑦3𝑡 )
If a long-run relationship exists, then Granger causality should exist in one or more directions
but the existence of Granger causality does not imply a long run relationship. One major anomaly
with the Granger (1969) test is that it is not unusual to observe the existence of a long-run relationship
but at the same time observe a non-valid Granger causal relationship among the variables (Toda and
Phillips 1993; Toda and Yamamoto 1995). Some of the reasons that contribute to non-validity of the
Granger causality tests (See Toda and Phillips [1993]; Gujrati [1995]) include:
(1) Sample size not large enough to satisfy the asymptotic assumptions underlying the Granger
causality test statistics.
(2) Wrongly identifying the order of integration of the variables (for instance due to small sample
or structural breaks), the Granger causality inference may be spurious: Even if one correctly
identifies the order of integration, cointegrating relationship, and the existence of a potential
maximum 𝑘 − 1 cointegrating vectors can also complicate the analyses: This is because critical
values are only valid on stationary or differenced stationary variables without the consideration
of potential long-run equilibrium.
(3) Specification bias arising from (as an example) the exclusion of important variables.
We do not envisage our study to suffer from the listed factors above .We however also used the
alternative causality test proposed by Toda and Yamamoto (1995) to complement our Granger
causality test. All things being equal, if our study does not suffer from any of the factors that
contributes to the non-validity of the Granger (1969) causality tests, then the Toda and Yamamoto
(1995) inferences should validate or be consistent with inferences made using the Granger (1969)
causality procedure. In applying the Toda and Yamamoto test, an estimated VAR (of the variables in
their levels) with pre-identified optimal lag (of size 𝑝 ) is augmented with further lags (of size 𝑑) and
re-estimated. 𝑑 is the maximum order of integration among the variables. It should be ensured that
the new VAR (𝑝 + 𝑑) is free of autocorrelation, otherwise the lag length should be increased until the
model is free of autocorrelation. The Wald restriction test for the Toda and Yamamoto procedure is

18 That is a test to examine whether two variables jointly Granger causes a third variable

17
only based on 𝑝 degrees of freedom. The included lags ensure that the Wald test is asymptotically
2
distributed as𝜒(𝑝) .
4 Estimations and Analyses of Results
This section presents analyses of our estimations. We used EViews for all our estimations

4.1 Order of Integration of the variables

Table Two shows ADF unit root test results. At the 5% level of significance, the ADF tests suggests
the presence of a unit root in the logarithm transformed series for all three variables. The null
hypothesis of existence of a unit root is however rejected for the differenced logarithm transformed
series indicating a 1st order integration. The natural progression is therefore to examine the long-run
equilibrium relationship between the variables.

Table Two: Augmented Dickey Fuller Test Results

Series ADF Test with Trend &
Intercept

Levels ADF Statistic: 0.501

GDP
First difference ADF Statistic: -7.414

Levels ADF Statistic: -1.752

EXP
First difference ADF Statistic: -15.701

Levels ADF Statistic: -3.191

IMP
First difference ADF Statistic: -16.181
𝐶𝑟𝑖𝑡𝑖𝑐𝑎𝑙 𝐷𝐹 𝑡(𝛼 =5% . 𝑛−𝑘−1=51) = −3.429

4.2. Cointegration Test Results

Table Three shows results of different lag lengths for the VAR system that may be potentially used
for the Johansen’s cointegration test. Three selection criteria (LR, FPE and AIC) suggest an optimum
lag of three whereas both the SC and HQC criteria suggest a VAR with one lag. It is not unusual to
observe different criteria producing different optimal lag lengths fits. This is because the five criteria
have different performances (Taylor and Peel 2000; Guerra 2003). McQuarrie and Tsai (1998)
suggested that all the criteria are usable provided the residuals of the estimated VAR are free from
autocorrelation. Results of the VAR residual serial correlation LM test (see Table Four in appendix)
shows non-rejection of the null hypothesis of no serial correlation in a VAR having a lag length of

18
one or three. We opted to use the VAR of lag length of three for our Johansen cointegration. Firstly,
three out of the five lag selection criteria supports this choice; secondly, effects of shocks to
macroeconomic variables do not mostly occur instantaneously. Thus, information contained in past
lags (free of serial correlation and wieldy) should be useful in a VAR modelling process. Both the
Trace and the Max-Eigen value tests (Table Five) indicate a rejection of null hypothesis of no
cointegration. This therefore confirms the existence of a long-run relationship among GDP, exports
and imports.

Table Three: Lag Order Selection Criteria for VAR System

Lag Log LR FPE AIC SC HQC
Length Likelihood
1 1129.351 NA 7.93 × 10−9 -10.13893 -10.00054* -10.08305*
2 1143.422 27.37806 7.58 × 10−9 -10.18482 -9.908044 -10.07306
3 1154.736 21.70632* 7.42 × 10−9 * -10.20576* -9.790597 -10.03812
4 1160.305 10.53197 7.65 × 10−9 -10.17470 -9.621155 -9.951190
* indicates lag order selected by the criterion

Table Five: Johansen’s Cointegration Results

Hypothesized No. Eigen MacKinnon-Haug-Michelis p-
Of cointegrated Values values
Equations Trace Test Max-eigenvalue test
None** 0.151193 0.0000 0.0001
At most one** 0.062682 0.0386 0.0417
At most two 0.006473 0.2237 0.2237
* *denotes rejection of the null hypothesis at the 0.05 level. Both the Trace and Max-Eigen value
tests indicate two cointegration equations.

Results of the Trace and Max-Eigen tests (Table Five) both finds two cointegration equations. The
VECM to be estimated (with the intercept and other exogenous intentionally omitted for simplicity)
is therefore similar to the regression-

19
 ∆𝐺𝐷𝑃𝑡 𝛼11 𝛼12 𝐺𝐷𝑃𝑡−1 Γ11,i Γ12,i Γ13,i ∆𝐺𝐷𝑃𝑡−𝑖
𝛼
[ ∆𝐼𝑀𝑃𝑡 ] = [ 21 𝛼22 ] [𝛽11 𝛽21 𝛽31 𝑝−1
Γ
] [ 𝐼𝑀𝑃𝑡−1 ] + ∑𝑖=1 [ 21,i Γ22,i Γ23,i ] [ ∆𝐼𝑀𝑃𝑡−𝑖 ] +
∆𝐸𝑋𝑃𝑡 𝛼31 𝛼32 𝛽12 𝛽22 𝛽32
𝐸𝑋𝑃𝑡−1 Γ31,i Γ32,i Γ33,i ∆𝐸𝑋𝑃𝑡−𝑖
𝜖1𝑡
[𝜖2𝑡 ] (13)
𝜖3𝑡
4.3. Analyses of VECM Estimates
Table Six in appendix shows the estimated cointegration coefficients (prior to performing robustness
checks). The obtained first and second cointegration vectors19 are respectively 𝛽̂ =
(1, 0, −0.922175) and 𝛽̂ = (0, 1, −0.946309). The estimated export coefficients in both equations
are statistically significant. Estimates of the adjustment coefficients are presented in Table Seven
(appendix). All estimated are statistically significant at the 5% critical level except the first adjustment
coefficient of the first cointegrating equation (𝛼11 ) and the third adjustment coefficient of the second
cointegrating equation (𝛼32 ) ; 𝛼32 is significant only at the 10% critical level. Since the first
adjustment coefficient of the first cointegrating equation is not statistically significant even at the 10%
level, we tested whether the variable associated with it is weakly exogenous20. The test result for the
null hypothesis of 𝛼11 = 0 is not rejected (See Table Eight in appendix). Thus GDP is weakly
exogenous with respect to the associated 𝛽̂ parameters. We can therefore exclude this from our
VECM as long as it does not affect the robustness of our estimates. Estimating the VECM using the
restrictions yields the output in Table Nine (appendix).
In order to confidently use our results for further analyses, we subjected the estimation to
some robust diagnostic tests that are widely applied to the Johansen’s framework. As can be observed
in Table Ten (in appendix), the 𝛼11 = 0 restriction does not affect the cointegration rank. Also the
model is free from autocorrelation the model however fails normality and homoscedasticity tests. In
the time series literature, non-normality and heteroscedasticity are sometimes caused by exogenous
events (reflected by outliers, jumps, shifts and structural breaks in the series).

19 ̂ 𝑆𝑘𝑘 𝛽̂ = 𝐼; 𝑆𝑘𝑘 defined in Johansen

Cointegrating vectors are identified in EViews using the normalization identity 𝛽′
(1991, 1995)
20 In the Johansen cointegration framework, a variable is said to be weakly exogenous if the associated adjustment

coefficient is zero. The maximum number of a weakly exogenous variable allowed in any cointegration system is 𝑘 − 𝑟
or 1 in our case (see, e.g., Hunter and Tabaghdehi, [2013] for further discussion).

20
 We included three dummy variables21 (dgdp, dexp and dimp) , historical volatility22 proxies
for both rand-dollar spot rates (zarvol) and US consumer sentiments (usconvol) to control for the
impact of exogenous events in our VECM estimation procedure. Historical rand-dollar volatility was
identified as an exogenous variable because not only is it exogenously determined (Baccheta and van
Wincoop 2001) but also it is exogenous to trade (Tenreyro 2007; Broda and Romalis 2011). Volatility
in US consumer sentiments was identified as an exogenous variable on the basis that none of the
variables is likely to affect it: However consumer shocks in the US is likely to spillover to South Africa
trade and growth prospects due to the enormous importance of the US economy to the global
economy. After experimenting with different combinations of the dummy variables and different lags
of exchange rate and US consumer volatility, we observed that seven lags helps to deal with the non-
normality and heteroscedastic issues that plagued our initial VECM estimation (Table Eleven in
appendix). Results of our VECM estimations with the non-normality and heteroscedasticity problems
corrected is presented in Table Twelve in appendix23.
The estimated export coefficients in both cointegration equations changes slightly following
our correction for the non-normality and heteroscedasticity problems. The normalized first
cointegration equation that describes the long-run relationship between GDP and export may be
represented as follows:
𝐺𝐷𝑃𝑡−1 = 4.003 + 0.8945𝐸𝑋𝑃𝑡−1 (14)

The positive relationship between export and growth is consistent with theoretical expectations. All
things being equal, a 1% increase in exports increases growth by approximately 0.90%. This is an
indication of South Africa’s exposure to the global economy; growth of South African economy is
thus very dependent on the growth of the economies of its trade partners. Thus in the long-run,
growth of South Africa’s economy is export-led. The normalized cointegration coefficients of the
second cointegration equation that describes the long-run equilibrium relationship between imports
and exports may be represented as:

𝐼𝑀𝑃𝑡−1 = 1.731 + 0.9242𝐸𝑋𝑃𝑡−1 (15)

21 dgdp, dexp and dimp are dummy variables for the GDP, export and import series. The dummy variables take a value
of 0 if an observation is an outlier and 1 otherwise. We classify an observation as an outlier if it is greater than Q 3 +
1.5IQR or less than Q 3 − 1.5IQR: Q 3 represents the 75th percentile value in each series and IQR is the inter-quartile
range.
22 Quarterly historical volatility values were generated using the square of quarterly percentage changes.
23 Due to the large size of full model, results of estimated coefficients of dummy variables and exogenous variables are

provided upon request.

21
From Equation 15, we observe that a 1% increase in exports increases imports by approximately
0.92% (all things being equal). A positive effect of exports on imports suggests that in the long-run,
South Africa’s capacity to import increases with increasing revenue from export (export impacting
imports via its impact on growth). This further confirms that long-run growth is export led. The
positive long-run relationship suggests a healthy sustainable relationship between export growth and
import growth in South Africa: This relationship allows the country to be competitive and have a
sustainable trade deficit or surplus. If large proportion of the revenue accruing to exports are used to
import intermediate inputs and capital goods then this should positively affect output in the long-run.
The estimated normalized cointegration equations describe the long-run equilibrium
relationships among the variables; any short-run deviations from these established relationships are
self-corrected through the error correction part of the model. CointEq1 represents the error
correction term for the estimated long-run relationship between GDP and exports. As an example, if
the system is in disequilibria with GDP above its long-run equilibrium in the current period, then
export should increase in the next period to bring the system back to equilibrium. For the short-run
error correction term which relates imports with exports, (CointEq2) if imports is above its long run
equilibrium in the current period, then exports should fall in the next period.
As can be inferred from Figure Two, our estimated VECM satisfies the conditions of a stable
cointegrated VAR. The estimated adjustment coefficients (after controlling for weakly exogenous
GDP24) are all statistically significant at the 5% level (Table Twelve in appendix). All the adjustment
coefficients for the first cointegration equation (𝛼21 and 𝛼31 ) are positive (all things being equal, they
move system away from equilibrium in the face of shocks) whereas those for the second cointegration
equation (𝛼12 , 𝛼22 and 𝛼32 ) are negative (all things being equal, they move system away from
equilibrium in the face of shocks). The VECM equation-by-equation regression output (with the
dummy variables and lags of the exogenous variables excluded) is as follows:
∆𝐺𝐷𝑃𝑡 = 0.121 + 0(−4.003 + 𝐺𝐷𝑃𝑡−1 − 0.894𝐸𝑋𝑃𝑡−1 ) − 0.0268(−1.732 + 𝐼𝑀𝑃𝑡−1 −
0.924𝐸𝑋𝑃𝑡−1 ) − 0.162∆𝐺𝐷𝑃𝑡−1 + 0.114∆𝐺𝐷𝑃𝑡−2 + 0.022∆𝐼𝑀𝑃𝑡−1 + 0.045∆𝐼𝑀𝑃𝑡−2 −
0.002∆𝐸𝑋𝑃𝑡−1 − 0.007∆𝐸𝑋𝑃𝑡−2 (16)

24GDP does not react to shocks emanating from changes in the long-run equilibrium between GDP and exports
(weakly exogenous to the first cointegration equation).

22
∆𝐼𝑀𝑃𝑡 = 0.331 + .1234(−4.003 + 𝐺𝐷𝑃𝑡−1 − 0.8944𝐸𝑋𝑃𝑡−1 ) − 0.0747(−1.732 + 𝐼𝑀𝑃𝑡−1 −
0.924𝐸𝑋𝑃𝑡−1 ) + 1.271∆𝐺𝐷𝑃𝑡−1 + 0.150∆𝐺𝐷𝑃𝑡−2 − 0.109∆𝐼𝑀𝑃𝑡−1 + 0.148∆𝐼𝑀𝑃𝑡−2 +
0.065∆𝐸𝑋𝑃𝑡−1 + 0.0131∆𝐸𝑋𝑃𝑡−2 (17)

∆EXPt = 0.519 + 0.0840(−4.003 + GDPt−1 − 0.8944EXPt−1 ) − 0.0596(−1.732 + IMPt−1 −

0.924EXPt−1 ) + 0.194∆GDPt−1 + 0.124∆GDPt−2 + 0.046∆IMPt−1 + 0.195∆IMPt−2 − 0.092∆EXPt−1 +
0.013∆EXPt−2 (18)
Equation 16 shows the estimated GDP regression of the VECM system. GDP only responds to
shocks from the changes of net exports (second cointegration equation) with adjustment speed to
equilibrium of 2%. Both the imports and exports regressions (Equations 17 and 18) of the VECM
system responds to shocks from changes in the two cointegrating equations. The adjustment to
equilibria from a shock to any of the long-run equilibrium relationship is a process that is a bit more
convoluted: Adjustment to equilibrium would depend on the magnitude of shock, interactions
between the two-cointegration equations and the size of the adjustment coefficients.

4.4. Analyses of Causality Test

Table Thirteen: Causality Tests Results
Null hypothesis 𝝌𝟐 for Granger 𝝌𝟐 for TY Causality Direction of Causality
Causality Test Test
IMP does not cause GDP 12.326*** 6.522 * IMP causes GDP
EXP does not cause GDP 0.187 6.173 EXP does not cause GDP
IMP, EXP does not cause GDP 12.329** 11.835* IMP, EXP jointly cause GDP
GDP does not cause IMP 15.615*** 25.626*** GDP causes IMP
EXP does not cause IMP 0.811 2.336 EXP does not cause IMP
GDP, EXP does not cause IMP 18.248*** 31.365*** GDP, EXP jointly cause IMP
GDP does not cause EXP 0.482 1.795 GDP does not cause EXP
IMP does not cause EXP 11.338*** 10.350** IMP causes EXP
GDP, IMP does not cause EXP 14.823*** 12.782** GDP, IMP jointly cause EXP
TY represents the Toda and Yamamoto (1995) test. ***, ** and * indicate rejection of non-causality test at the 1%, 5%
and 10% level of significance

Apart from the test for causality from export and imports (both individually and jointly) to GDP, we
observe that the Toda and Yamamoto (1995) method fairly complements the results of the Granger
causality tests). According to Engle and Granger (1987), if cointegration exists amongst variables then
at least there must be Granger causality in one direction. The Toda and Yamamoto (1995) test may

23
therefore not be appropriate since it did not suggest any form of causal association between GDP and
export. We therefore relied on the Granger (1965) causality test for our short-run analysis.
From the Granger causality tests results, we observed a bidirectional causal relationship
between GDP and imports. This finding suggests that in the short run, current changes in either of
the two variables is drives growth in the other. These empirical evidence are consistent with theoretical
expectations: On the one hand, periods of economic upswing cause consumption to increase: Imports
helps to mitigate the buoyant demand if domestic production capacity is constrained by available
resources. On the other hand, it is also not unusual to observe imports causing growth in an emerging
economy like South Africa. Theory and mainstream contributions suggests that imports could
stimulate economic growth in many ways including: improving productivity as they serve as channels
for the transmission of new ideas and technology; improving production through capital formation
from the inflow of intermediate inputs; enhancing efficiency and hence output by rechanneling a
country’s cheap and abundant factors to its comparative advantage commodity and finally; increasing
capital accumulation through the savings made from purchasing cheaper imports. The unilateral causal
relationship from the direction of imports to exports 25 further underscores the importance of imports
to export production.
In a multiple regression analysis, focusing on pairwise causal relationship between variables
may fail to provide us the full information of the true causal relationship(s). This is because pairwise
causal analysis fails to account for the effect of joint variations in two or more independent variables
on a dependent variable. Our causality test results confirms this! Although the test did not reveal a
pairwise causal relationship in any direction between GDP and export, it however suggest that imports
and exports jointly causes GDP growth. This observation further supports our earlier explanation on
the interaction of imports as inputs to exports production and consequently future export growth.
The test results also reveal that GDP and export jointly causes imports. This is attributable to the fact
that South Africa capacity to sustain future import growth depends on the interaction between past
economic growth and foreign exchange earnings from previous export growth. Finally, the tests also
reveal that GDP and import jointly causes exports. Undeniably, interaction between previous GDP
and import growth should be important to future export growth especially if previous growth in
income enhances South Africa’s capacity to increase import inputs for further expansion in export
production.

25This suggests that import is exogenous to export. This further confirms the appropriateness of the order in which the
variables appear in the VECM.

24
4.5. Summary of results
In summary, our results suggested a sustainable long-run equilibrium relationship between GDP,
export and import: In the long-run export drives economic growth which is consistent with the
mainstream contributions and existing theory. Unlike most of the previous studies however, we also
observed that export determines capacity to import for South Africa in the long-run. Thus economic
and import growth are both export-led in the long-run. Our short-run analysis based on Granger
causality test on our estimated VECM sheds further light on the relationship between the three
variables Empirical evidence suggest that export does not drive growth in the short-run for South
Africa. We further observed a bidirectional Granger causal relationship between GDP and imports.
Causality from growth to import is evidence that growth induced excess consumption (consumption
beyond domestic production capacity) is met with increasing imports. Respectively, causality from
import to growth may be an indication of how important imports are to growth prospects. Our
observation of unilateral causality from imports to exports further underscores the importance of
imports to exports production. We also observed causality running jointly from two of the variables
to the third, an indication of the importance of interactions between any variable pairs to the growth
of the third variable.
The empirical evidence from our study shows the significance of imports to the trade-growth
nexus for South Africa: This therefore questions the robustness of results of similar studies that mainly
focus on the bilateral relationship between export and economic growth and the policy prescriptions
associated with such findings. The next section provides further discussion and policy implications of
our findings.
5. Further Discussion and Policy Recommendation
It is well known that integration into the world economy, specifically through trade, facilitate real
economic growth and subsequently development and welfare. Although the export-led growth
strategy shows some potential in facilitating real growth, there is also a growing evidence that some
countries have not enjoyed robust economic growth by following this strategy 26 . Given South Africa’s
aggressive strategies in promoting exports (through various policies such as the Industrial Policy
Action Plan, the National Development Plan and the New Growth Path), any relevant information
on how participation in the global economy affects South Africa’s economic prospects should be

26 On the one hand, countries including Hong Kong, Ireland, South Korea and most recently China have experienced
success with the ELG strategy, on the other hand however, experiments with the strategy have not contributed
significantly to output in most Latin American and African countries (See e.g., Felipe [2003] and Zepeda et al [2009] )

25
important to policymakers. Predictably, most studies on the trade-growth nexus in the South Africa’s
context do not analyze the contributions of imports to productivity and further economic growth, as
well as the potential virtuous cycle that may ensue between the GDP, export and imports: Our
empirical evidence that revealed contributions of imports to economic growth for South Africa is
therefore important to the trade-growth nexus debate and can be exploited by policymakers to the
benefit of the South African economy.
We analyzed the long-run equilibrium relationship among GDP, export and imports using the
Johansen Cointegration method and observed that robust long-run estimates are obtained if external
volatilities from exchange rates, world economic condition and other exogenous events are controlled
for. We observed that long-run economic growth and sustainable capacity to import is driven by
export growth for South Africa. Our policy recommendation based on the long-run relationships is
that South Africa should continue to pursue its export oriented policy as it remains important to
economic growth. The challenges facing policy makers is that pursuing an export driven economy
exposes the country to shocks. In fact, we all observed how the recent global crisis exposed the
vulnerabilities of many nations where export is an important channel for economic growth. The extant
literature on the recent crisis recommends the use of countercyclical policies 27 (Fernandez-Arias and
Montiel 2011), greater diversification of trade partners and deeper regional integration (Ncube,
Brixiova and Meng 2014) as some of the important factors that can act as buffers to negative external
shocks. The important lessons learnt in the aftermath of the global crises should inform policy makers
in mitigating the effects of negative shocks on real growth.
Results of Granger Causality tests between the three variables in a VECM system reveals very
useful short-run causal links through imports that the policy maker can leverage upon to boost South
Africa’s growth aspirations. Our observation of bidirectional causality between economic growth and
import as well as the positive impact of import on export suggests that initially stage, economic growth
stimulates growth in imports. With time, imports may stimulates productivity , further economic
growth and consequently a vent-for-surplus gains through many channels including the transmission
of new ideas and technology; by increasing capital formation and accumulation, as well as helping the
country to channel its cheap and abundant factors to efficient production. The importance of imports
to the trade-growth nexus for South Africa is further reflected through the observed joint causality
running from any selected variable pair to a third variable. Our policy recommendation is as follows:

27Involving using previous savings for moderate fiscal expansion to counteract the negative impact of external shocks
on export demand.

26
Whilst our findings underscores the importance of imports to growth for South Africa, the extent to
which imports can significantly enhance economic and export growth largely depends on the capacity
of the economy to channel imports into productive use. The challenge to the policymaker is therefore
to design policies that ensures that import are channeled to economic activities that improves future
output and positive outcomes.

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Appendix One: Tables

Table Four: VAR Residual Serial Correlation LM Test
Lags LM-Stats Prob
1 11.0611 0.2715
2 15.2382 0.0846
3 11.1417 0.2661
𝑯𝟎 : No serial correlation. Rejection rule: Reject null if probs
from 𝝌𝟐(𝟗) is less than 0.05.

Table Six: Initial Estimated Normalized Cointegration Coefficients

Cointegration Normalized Coefficients
Equations

1 GDP IMP EXP

1.0000 0.0000 -0.922173***
[-61.1475]
2 GDP IMP EXP
0.0000 1.0000 -0.946309***
[-69.0244]
T-statistics in parenthesis. ***, ** and * indicate significance at 1%, 5% and 10%
respectively

31
Table Seven: Adjustment Coefficients
Variables Cointegration Equation 1 Cointegration Equation 2
Adjustment Coefficients Adjustment Coefficients
∆𝑮𝑫𝑷 0.004391 -0.033604***
[0.4890] [-4.73695]
∆𝑰𝑴𝑷 0.141622*** -0.110454***
[3.2637] [-3.22173]
∆𝑬𝑿𝑷 0.095525** -0.053792*
[ 2.36003] [-1.68210]
T-statistics in parenthesis. ***, ** and * indicate significance at
1%, 5% and 10% respectively .

Table Eight: Estimated Adjustment Coefficients

Hypothesized Restricted LR-Stats Probs
Number Log-Likelihood
Of CE(s)
2 1207.263 0.2437 0.6215
𝑯𝟎 : 𝜶𝟏 = 𝟎. Rejection rule: Reject null if probs from 𝝌𝟐(𝟏) is less than 0.05.

32
Appendix One: Tables

Table Nine: Initial VECM Estimation

Cointegration
Restrictions:
𝛽11 = 1; 𝛽12 = 0; 𝛽21 = 0; 𝛽22 = 1; 𝛼11 = 0
Cointegration Equations Equation 1 Equation 2
𝑮𝑫𝑷𝒕−𝟏 1.0000 0.0000

𝑰𝑴𝑷𝒕−𝟏 0.0000 1.0000

𝑬𝑿𝑷𝒕−𝟏 -0.9218*** -0.9470***

[-63.542] [-67.644]

𝑪 -3.3719 -1.2038
Error Correction ∆𝑮𝑫𝑷 ∆𝑰𝑴𝑷 ∆𝑬𝑿𝑷
CointEq1 0.0000 0.1379*** 0.0886**
[NA] [3.2401] [2.3111]

CointEq2 -0.03132*** -0.1089*** -0.0501

[-5.9250] [3.2401] [-1.600]

∆𝑮𝑫𝑷𝒕−𝟏 -0.071094 1.550839*** 0.177485

[-1.00250] [ 4.52625] [ 0.55515]

∆𝑮𝑫𝑷𝒕−𝟐 0.105529 -0.000176 0.156470

[ 1.43156] [-0.00049] [ 0.47083]

∆𝑰𝑴𝑷𝒕−𝟏 0.025404* -0.101716 0.054067

[ 1.69445] [-1.40419] [ 0.79991]

∆𝑰𝑴𝑷𝒕−𝟐 0.039922*** 0.145034** 0.163567***

[ 2.93512] [ 2.20698] [ 2.66748]

∆𝑬𝑿𝑷𝒕−𝟏 -0.004144 0.058290 -0.064430

[-0.26178] [ 0.76211] [-0.90279]

∆𝑬𝑿𝑷𝒕−𝟐 -0.004541 -0.064937 -0.022430

[-0.28907] [-0.85556] [-0.31672]

C 0.026752*** -0.017093 0.017429

[ 8.74897] [-1.15699] [ 1.26438]
R-Squared 0.242 0.212 0.062
F-Statistics 8.832 7.410 1.817
AIC -5.426 -2.276 -2.414
T statistics in parenthesis. ***, ** and * indicate significance at 1%, 5% and 10% respectively

33
Appendix One: Tables

Table Ten Initial VECM Diagnostic Tests

Test P-Value Pass/Fail
Existence of two 0.038/0.031 Pass
cointegration equations
(Max eigenvalue/trace)
𝜶𝟏𝟏 = 𝟎 Restriction 0.6215 Pass
Autocorrelation –LM Test 0.0970 Pass
Jacques-Bera Normality 0.0000 Failed
Test
White heteroscedasticity 0.0000 Failed
Test

Table Eleven: Diagnostic Tests for VECM (corrected for non-normality and
heteroscedasticity)
Test P-Value Pass/Fail
Existence of two 0.00138/0.0099 Pass
cointegration equations
(Max eigenvalue/trace)
𝜶𝟏𝟏 = 𝟎 Restriction 0.1723 Pass
Autocorrelation –LM Test 0.0770 Pass
Jacques-Bera Normality test 0.1221 Pass
White heteroscedasticity 0.0677 Pass
Test

34
Appendix One: Tables

Table Twelve: VECM Corrected for Non-Normality and Heteroscedasticity

Cointegration
Restrictions:
𝛽11 = 1; 𝛽12 = 0; 𝛽21 = 0; 𝛽22 = 1; 𝛼11 = 0
Cointegration Equations Equation 1 Equation 2
𝑮𝑫𝑷𝒕−𝟏 1.0000 0.0000

𝑰𝑴𝑷𝒕−𝟏 0.0000 1.0000

𝑬𝑿𝑷𝒕−𝟏 -0.8945*** -0.9242***

[-51.321] [-49.771]

𝑪 -4.003697 -1.731216
Error Correction ∆𝑮𝑫𝑷 ∆𝑰𝑴𝑷 ∆𝑬𝑿𝑷
CointEq1 0.0000 0.1234*** 0.0840**
[NA] [3.2325] [2.4182]

CointEq2 -0.0268*** -0.0747** -0.0596**

[-5.7622] [-2.3439] [-2.0126]

∆𝑮𝑫𝑷𝒕−𝟏 -0.162048** 1.271264*** 0.193613

[-2.33483] [ 3.94808] [ 0.63137]

∆𝑮𝑫𝑷𝒕−𝟐 0.113556 0.150282 0.123672

[ 1.55964] [ 0.44489] [ 0.38443]

∆𝑰𝑴𝑷𝒕−𝟏 0.022981 -0.108869 0.045591

[ 1.56464] [-1.59764] [ 0.70251]

∆𝑰𝑴𝑷𝒕−𝟐 0.045407*** 0.147718** 0.194767***

[ 3.45793] [ 2.42474] [ 3.35695]

∆𝑬𝑿𝑷𝒕−𝟏 -0.002112 0.064725 -0.092247

[-0.13563] [ 0.89590] [-1.34072]

∆𝑬𝑿𝑷𝒕−𝟐 -0.006627 0.013198 0.013414

[-0.42240] [ 0.18132] [ 0.19351]

C 0.121140*** 0.331480*** 0.519102***

[ 5.64136] [ 3.32731] [ 5.47124]
R-Squared 0.42 0.44 0.31
F-Statistics 5.183 5.731 3.229
AIC -5.521 -2.452 -2.549
T statistics in parenthesis. ***, ** and * indicate significance at 1%, 5% and 10% respectively

35
Appendix Two: Figures

Figure Two: Stability Test.

Inverse Roots of AR Characteristic Polynomial

1.5

1.0

0.5

0.0

-0.5

-1.0

-1.5
-1 0 1

36