Empirical Framework of the Study
6.7 Description of Variables and Their Expected Signs in Remittances- Growth Model
1) Workers’ remittances can affect economic growth positively or negatively as suggested by theory and existing literature. Therefore, it is difficult to predict the exact sign of the coefficient of REM in advance.
2) Capital is represented by gross fixed capital formation. We assume capital is very important for economic growth thus expecting a positive coefficient of gross fixed capital formation.
3) The coefficient of economically active population is expected to have a positive effect due to the increased availability of labor. Increased population tends to results in increased labor supply which has a positive effect on economic growth.
4) The relation between economic growth and exchange rate is ambiguous.
Theoretically, the appreciation of local currency reduces export earning and hence reduces growth. However, the impact of currency appreciation and depreciation depends on the economic situation of a particular country and it cannot be predicted accurately. For some countries, exchange rate is an important policy instrument. In this equation, exchange rate also controls for the macro-economic volatility.
5) Inflation rate has been used as a measure of macroeconomic stability in growth literature. Although Temple (1999) claims that the association between growth and inflation is controversial, evidence found by Fischer (1993), Bruno and Easterly (1998), Fuentes and Kennedy (2009) weighs heavily on inflation having negative impact on growth. High inflation can create political instability and other adverse situation that can depress long term investment. We expect a negative coefficient of inflation rate.
6) Foreign direct investment is used to capture the effect of external sources of capital on growth. The sign of this parameter is expected to be positive as foreign direct investment is widely viewed as transfer of (new) technology and (new) knowledge which enables the recipient country to exploit the experience of others for their
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development. Chami et al (2008) state that foreign direct investment is positively correlated with output growth during the 1990s.
7) The official development assistance (ODA) is used to capture the impact of an external source of capital on economic growth. Proponents of aid argue that overseas capital flows are necessary for the economic growth of developing countries (Chenery and Strout, 1955; Fayissa and El-Kaissy, 1999). On the other hand, opponents of foreign aid argue that it has a negative effect on domestic savings and economic growth in less developed countries (Boone, 1994). So the coefficient of ODA can be positive or negative.
8) Trade (i.e. export plus import) as a share of GDP is used to measure the impact of openness or trade of the economy on economic growth. Traditional views of openness of the country to trade describe positive effect of the openness on the economic growth, allowing countries to allocate resources efficiently by promoting innovation and entrepreneurial activities resulting from competition and access to larger markets. We expect a positive coefficient of the variable.
9) Government consumption expenditures are very commonly used as a fiscal policy measure. The coefficient of government consumption is expected to be negative.
Because government consumption is regarded as non-productive investment and thus negatively impact economic growth. Such spending is sometimes associated with the crowding out effect which has negative effect on financial development and growth. Although government expenditures do not affect productivity directly, it brings about distortion in private decision and thus hampers growth. In addition, if government is too big, then higher spending undermines economic growth by transferring additional resources from the productive sector of the economy to government, which uses them less efficiently.
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10) Domestic credit to private sector (DCPS) in this model indicates the financial depth of a country. Levine and Renelt (1992) find domestic credit positively related to growth which is also the assumption of this study.
11) Institutional quality and various environmental factors are captured by the political, economic and financial risk indicators. Well-functioning political and legal institutions help sustain growth (Barro and Sala-i-Martin, 2004). Evidence indicates that growth enhancing policies are less effective when political environment is unstable and institutions are weak. Economic policies and strong institutions are instrumental in shaping overall environment to foster growth. Thus countries showing less risk in terms of risk indicators should be able to grow more.
Sen (1999) argues that freedom (political, economic, social, transparency and security) is a necessary condition for economic growth and development. Thus, we use the political rights index (PR) to capture the effect of this institutional factor, obtained from the Freedom House’s Freedom in the World Country Ratings. The political rights index goes from 1 to 7, where 1 denotes “most free” and 7 denotes the least level of political liberty. Hence, we expect the sign of the political rights index to be negative.
12) Theory of economic growth predicts that countries that start out with low levels of income tend to grow relatively faster than the countries with higher initial income and that allows low level income countries to converge to the higher income countries. Hence, it is logical to expect negative sign of the coefficient of this parameter, but Blomstrom (1995) contradicts this prediction of convergence. The impact of the initial level of GDP (RGDP) on economic growth has been controversial. On the one hand, Casseli, et al. (1996) reports a positive relationship between growth rate and the initial level GDP through its positive impact on capital formation. On the other hand, Barro (1997) finds a negative relationship between the initial GDP and the GDP growth rate in a cross-country empirical study which interprets to imply a case of conditional convergence. Consequently, we cannot, a priori, predict the sign of the initial level of GDP coefficient.
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