Causality between Foreign Trade and Economic growth: evidence from Kenya (1970-2017)

Abstract

The study of foreign trade and economic growth has mainly focused on two main hypotheses; export led growth and import led growth hypothesis. Conflicting results have been reported whereby export and import led growth have been found to be valid for some countries and not valid for some. This study therefore sought to answer the question whether or not foreign trade causes economic growth in Kenya. Specific objectives include; determining causality between exports and economic growth, to find out causality between imports and economic growth, to determine causality between openness to trade and economic growth and to determine causality between foreign direct investment and economic growth. The following hypotheses were tested; exports, imports, volume of trade and foreign direct investment inflows do not cause economic growth. The study was based on the international trade theory. This study adopted both descriptive and explanatory research designs. ARDL and Granger Causality models were used to test the relationship and causal direction among the variables. Annual time series data for the years 1970 to 2017 from World Bank databank was used. Data analysis entailed unit root test, cointegration analysis, Granger Causality test and finally running model diagnostic tests. Wald Test of Cointegration (F-statistic = 6.0802) revealed that long run equilibrium relationship exist between imports, foreign direct investment, exports, openness to trade and economic growth. Further analysis showed that imports (p=0.1798), foreign direct investment (p=0.3129), exports (p=0.1798) and openness to trade (p=0.0750) were not significant in determining economic growth in the long run. In the short run period, imports (p= 0.0084) were significant and positively related to economic growth. Openness to trade (p= 0.0149) was significant and negatively related to economic growth. Other variables such as FDI (p=0.8983) and exports (p=0.1987) were not significant in determining economic growth in the short run. Granger causality tests revealed that there was no causality between FDI (p=0.8972), openness to trade (p=0.9224), imports (p=0.3110), exports (p=0.3827) and economic growth in the long run at 5 percent level of significance. Since imports, exports, FDI and openness to trade do not cause economic growth in the long run, the study concluded that import and export led growth hypothesis are not supported in Kenya. In order to realize positive gains from foreign trade, policy recommendations include; encouraging more FDI inflows, more trade openness to attain a positive impact on economic growth