Effect of manufactured exports, financial development and foreign direct investment on service exports in Kenya

Abstract

Trade in services has been found to be the new engine at driving economic growth based on its ever increasing contribution towards the GDP and employment in many economies. It has also been found that trade in services is least affected by economic shocks as compared to trade in goods. With Kenya’s global service exports having dropped by 11.3 percent, the main objective of this study therefore was to determine the factors that affect Kenya’s service exports. The specific objectives of the study were to evaluate the effect of manufacturing exports, financial development and foreign direct investment on Kenya’s service exports. Heckscher-Ohlin theory of international trade guided the study. World Development Indicators (WDI) and United Nations Conference on Trade and Development (UNCTAD) were the main sources of the time series data set. The data spans for period of thirty eight years from 1980 to 2017. The dependent variable of the study was Kenya service exports while the independent variables were manufacturing exports, financial development and foreign direct investment. This study applied explanatory research design in examining the effect of manufactured exports, financial development and foreign direct investment on Kenyan service exports to the global world. The STATA statistical software version 14 was used for the data analysis. The data was first transformed to log-linear before stationarity was tested using Augmented Dickey-Fuller test and Philips Perron test. The Likelihood Ratio (LR), the Akaike Information Criterion (AIC), the Hannan Quinn Information Criterion (HQIC) and the Swartz Bayesian Information Criterion (SBIC) were used to determine the optimal number of lags for each variable prior to testing for stationarity. The Auto-Regressive Distributed Lagged (ARDL) model approach to cointegration was used to test the null hypotheses. Cointegration results (F=14.465>I (0) =6.119, I (1) =7.666) revealed existence of a significant long run relationship between the dependent variable (Kenya service exports) and independent variables (manufactured exports, financial development and foreign direct investment). The ARDL analysis results revealed that services exports are significantly affected by manufactured exports (β 1 =1.668, p=0.000<.01) and financial development (β 2 =1.235, p=0.006<.01). The Error Correction Model revealed a speed of 57.5 percent (- 0.575) adjustment to equilibrium with significance (p=0.000) affirming the existence of long run relationship between the dependent variable (Kenya service exports) and the independent variables (Manufactured exports, financial development and foreign direct investment). The study found that manufactured exports and financial development have a positive and significant effect on Kenya service exports in the long run. The study recommended: first; since an increase in manufacturing exports leads to an increase in demand for services such as communication, travelling and business related services, the government should enact policies that are friendly for the easier establishment of more export manufacturing firms and provide more business related incentives like easy access to foreign markets to enable further expansion of these export manufacturing firms. Secondly, since access to finance is important in enabling service firms in meeting their capital needs, the government should enact policies that encourage financial institutions offer cheap, inclusive and flexible financial assistance to service sector firms that can enable them expand and increase their service exports globally