The causal relationship among financial development, trade openness, and economic growth in Zambia(1965-2011)
Date
2015-02-26
Authors
Zombe, Chibvalo
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Abstract
The aim of this study was to investigate the causal relationship among financial development, trade openness, and economic growth in Zambia from 1965 to 2011. To fully understand this relationship, two measures of financial development were used: broad money and domestic credit to the private sector, each as a ratio of gross domestic product (GDP). In this regard, two models were developed for each indicator. Using Augmented Dickey-Fuller (ADF) and Phillips-Perron (PP) stationarity tests we found that all the variables were integrated of order one. Furthermore, Johansen’s test for cointegration indicated that the variables in each model had one cointegration relationship. Therefore, the vector error correction model (VECM) was employed to examine the short-run and long-run dynamics among the variables in each model. The results indicate that relationship among financial development, trade openness, and economic growth is sensitive to the financial development indicator chosen.
In the short run, we found that economic growth and trade openness Granger cause financial development. This result was obtained when using domestic credit to the private sector as an indicator of financial development. Moreover, using the same indicator, we found a unidirectional relationship running from trade openness to financial development, though in a negative way. Using broad money as an indicator of financial development, we found no causal relationship among financial development, trade openness, and economic growth.
In the long run, we found that financial development and trade openness cause economic growth when broad money is used as an indicator of financial development. On the other hand, we found that economic growth and trade openness cause financial development when domestic credit to the private sector is used as a measure of financial development. However, in both cases, the causal link was found to be weak suggesting that Zambia’s financial sector is still in its infancy stage and exhibits some characteristics of financial repression. Furthermore, Zambia’s trade policies thus far have not contributed much to economic growth.
On the policy front, it is important for policy makers in Zambia to pursue policies that further open up the economy to international trade with caution. This is because trade openness hinders the growth of domestic credit to the private sector in the short run. Notwithstanding, some degree of openness to international trade is also important since trade openness and economic growth jointly increase the supply of domestic credit to the private sector. Therefore, the focus of trade policy should be on finding the appropriate degree of trade openness that will support domestic credit to the private sector given the rate of economic growth.
In the long run, policy makers should consider policies that increase broad money and trade openness as they are important factors in promoting economic growth. With high economic growth rates coupled with increased international trade it is envisaged that domestic credit to the private sector will increase.
Description
MA Dissertation
Keywords
Zambia-Economic Conditions , Investments-Zambia