View of TRADE LIBERALIZATION AND ECONOMIC GROWTH PROCESS IN INDIA: AN EMPIRICAL ANALYSIS

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Vol. 05,Special Issue 02, (IC-IRSHEM-2020) February 2020, Available Online: www.ajeee.co.in/index.php/AJEEE

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TRADE LIBERALIZATION AND ECONOMIC GROWTH PROCESS IN INDIA: AN EMPIRICAL ANALYSIS

SACHIN KUMAR, Research Student,

Institute of Economics and Finance, Bundelkhand University, Jhansi (U.P) DR. SHAMBHU NATH SINGH, Ph.D Supervisor and Professor, Institute of Economics and Finance, Bundelkhand University, Jhansi (U.P)

Abstract:- This paper studies the relationship between the trade liberalization and economic growth process in India. The Augmented Dickey Fuller test (ADF) and Phillips- Perron (PP) tests are used to check the order of integration of the variables and at this level all the variables were non-stationary, which means that null hypothesis cannot be rejected.

However, the stationarity found at their first difference of the series is significant. We apply Johansen co-integration method found 1 cointerating vector, that there exists a long run relationship between international trade openness and growth. Our Granger causality results show that causality follows from GDP to Trade Openness and support trade-led hypothesis. Results also support the idea that country may experience faster per-capita growth with a growing degree of international trade through gains in country productivity associated with availability of finance in the market. Finally, the direction of the causality results followed trade led growth.

Keywords: Trade liberalization, economic growth, co-integration, India. JEL Classification:

G21, E44, O16.

1. INTRODUCTION

Ever since Ricardo's critique on the Corn Laws to the current debate on globalization, few topics in economics have been more hotly contested than the importance of openness to international trade for economic development and growth. The arguments in favour of openness are well known and date back at least to Adam Smith‟s analysis of market specialization: openness promotes the efficient allocation of resources through comparative advantage, allows the dissemination of knowledge and technological progress, and encourages competition in domestic and international markets; also, recent theoretical models indicate a long-run growth effect when the areas of specialization promoted by trade enjoy increasing returns to scale. But opposing arguments are not too hard to build: if market or institutional imperfections exist, openness can lead to under-utilization of human and capital resources, concentration in extractive economic activities, or specialization away from technologically advanced, increasing-return sectors.

Trade openness is measured in terms of exports incremented by imports as a share of Gross Domestic product of a country and distinctly refers to the inward and outward orientation of the Economy of a Nation. Numerous findings have established a broad- spectrum and positive association between trade openness and growth on average, but several of them are flawed by operational inadequacies and significant inexplicable dissimilarity in the results. The Indian Economy has experienced downturn and economic dynamics through due course of time. After Trade Liberalization policy implementations in India the scenario of Indian Trade and Economy changed significantly. The future forecast of Trade Liberalization represents a positive depiction in the Indian Economy altogether.

Trade (both imports and exports) playsa vital role for any successful modem economy and is crucial for the competitiveness of the Indian economy in the long run also.

Referring to large body of evidences, exposed firm scan exercise significant competition and comparative advantages when they have international competition. The structure of Indian economy has undergone significant changes since 1991 with globalization polices which majorly includes changes in International trade. After the structural reforms in India, the exports and imports have considerably increased which has positively impacted the Gross Domestic Product in order to focus on $5 Trillion economy. India is one of the G20 Nations and her GCI rank has been estimated to be 71 among the rest of the world (G20 India Secretariat, 2015).

In terms of Economic literature the word 'Openness' has been under common usage since 1980s. Most of the times openness itself signifies Trade Openness is an indicator, which will be influenced by trade policies adopted by India and also the result of

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multilateral trade negotiations, and by the wider macroeconomic state of the world economy. Restrictive trade policy will inhibit other countries from sending exports and accepting imports from the country, which practices it. According to dominating economic theory, this restrictiveness, this absence of openness, will result into of slowing the economic development or growth. Inversely, trade openness will have an economic effect of increasing economic development and growth. In distinguishing budding impact of trade openness in the Indian Economy, it had been crucial to focus on altering trade policy regimes.

After liberalization of Indian Trade services have provided new opportunities since 2003-2004 after advent of new avenues (trades of software and IT related services).The study I have tried to study the trade openness of Indian Economy during different pre and post reform periods. The analytical content and empirical analysis mainly focuses on the period of 1970 to 1991 (Pre liberalization) and 1992 to 2018 (Post liberalization) in India.

The research question concentrated in my study is “whether there is a significant difference between trade openness Pre - Post liberalization era”.

The portion of exports of goods and services to Gross Domestic Product has increased from 6% in 1971 to8.5% in 1991,whereas after liberalization in 1991 the share has considerably increased to 13.2% in 2001 and19.74% in 2018 (World Bank database,2019). The share of imports of goods and services to GDP has decreased from 8.7% in 1981 to 8.5% in1991, whereas after liberalization in 1991 the share considerably increased to 13.6%in2001 and23.64%in2018 (World Bank database, 2019).

2. INDIAN FOREIGN TRADE OVERVIEW

Foreign trade in India began in the period of the latter half of the 19th century. The period 1900-1914 saw development in India's foreign trade. The augment in the production of crops as oilseeds, cotton, jute and tea was mainly due to a thriving export trade. In the First World War, India's foreign trade decelerated. After post-war period, India's exports increased because demand for raw materials was increased in all over world and there were elimination of war time restrictions. The imports also increased to satisfy the restricted demand. Records indicated that India's foreign trade was rigorously affected by the great depression of 1930s because of decrement in commodity prices, decline in consumer's purchasing power and unfair trade policies adopted by the colonial government. During the Second World War, India accomplished huge export surplus and accumulated substantial amount of real balances. There was a huge pressure of restricted demand in India during the Second World War.

The import requirements were outsized and export surpluses were lesser at the end of the war. Before independence, India's foreign trade was associated with a colonial and agricultural economy. Exports consisted primarily of raw materials and plantation crops, while imports composed of light consumer merchandise and other manufactures. The structure of India's foreign trade reflected the organized utilization of the country by the foreign leaders. The raw materials were exported from India and finished products imported from the U.K. The production of final products was discouraged. For instance, cotton textiles, which were India's exports, accounted for the largest share of its imports during the British period. This resulted in the decline of Indian industries. Since last six decades, India's foreign trade has changed in terms of composition of commodities. The exports included array of conventional and non-traditional products while imports mostly consist of capital goods, petroleum products, raw materials, intermediates and chemicals to meet the ever increasing industrial demands.

The export trade during 1950-1960 was noticeable by two main trends. First, among commodities which were directly based on agricultural production such as tea, cotton textiles, jute manufactures, hides and skins, spices and tobacco exports did not increase on the whole, and secondly, there was a significant boost in the exports of raw manufactures such as iron ore. In the period of 1950 to 1951, main products dominated the Indian export sector. These included cashew kernels, black pepper, tea, coal, mica, manganese ore, raw and tanned hides and skins, vegetable oils, raw cotton, and raw wool. These products comprised of 34 per cent of the total exports. In the period of 1950s there were balance of payments crunch. The export proceeds were not enough to fulfil the emerging import

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demand. The turn down in agriculture production and growing pace of development activity added pressure.

The external factors such as the closure of Suez Canal created tension on the domestic financial system. The critical problem at that moment was that of foreign exchange scarcity. One of the most important phenomena in post war economic history has been the enormous expansion of world trade. India trade grew poorly from 1950 to 1980 as compared with world trade. India entered into planned development era in 1950„s and at that time Import Substitution was a major element of India„s trade and industrial policy. In 1950 India„s share in the total world trade was1.78%which reduced to 0.6% in 1995. In 1993, India rank 33rd in top exporting countries and 32nd in top importing countries.

Natural Resources of the country are not evenly divided amongst public and private sector business enterprises. During 2003-04 India„s share in the global trade was 0.8%, in 2005 it was 1.0%.

The PC Alexander Committee (1978) was the first committee to review and recommend on Import –Export Policies and Procedures. This committee recommended the simplification of the Import Licensing procedure and provided a framework involving a shift in the emphasis from ―control to development‖. In 1980 Tandon Committee gave recommendations on export strategies in eightees. In the Export Import policy of 1978-79, for the first time in India„s History decentralization of some licensing functions took place and the powers of regional licensing authorities was enhanced. Export Oriented Units were set up under the EOU scheme introduced in early 1981. The export and Import Bank of India (website) was set up in 1982 to take over the operations of international finance wing of the IDBI.

Other major objectives were to provide financial assistance to exporters and importers. In the Trade Policy of 1985-88 some measures were taken based upon the recommendation of Abid Husain Committee 1984. This committee envisaged ―Growth Led Exports, rather than Export Led Growth‖. The recommendation of this committee stressed upon the need for harmonizing the foreign trade policies with other domestic policies. This committee recommended announcement of foreign trade policies for longer terms. The export import pass book scheme was introduced in 1985 as per recommendation of Abid Hussain Committee. In 1985 Visvanathan pratap Singh Government developed a 3 year Exim policy. Tax Reform Committee chaired by Raja J Chelliah suggested minimizing the role of quantitative restrictions and reducing the tariff rates substantially. Export Processing Zones were set up to push up export In order to liberalize imports and boost exports, the Government of India for the first time introduced the Indian EXIM Policy on AprilI, 1992.

In the light of the reform policy objectives successive governments have been taking various trade reforms. Successive annual Union Budgets have also extended a number of tax benefits and exemptions to the exporters. These include reduction in the peak rate of customs duty to 15 per cent; significant reduction in duty rates for critical inputs for the Information Technology sector, which is an important export sector; grant of concessions for building infrastructure by way of 10-years tax holiday to the developers of SEZs;

Facilities and tax benefits to exporters of goods and merchandise; reduction in the customs duty on specified equipment for ports and airports to 10 per cent to encourage the development of world class infrastructure facilities, etc.

A number of tax benefits have also been announced for the three integral parts of the “convergence revolution” the Information Technology sector, the Telecommunication sector, and the Entertainment industry. In order to bring stability and continuity, the Export Import Policy was made for the duration of 5 years. However, the Central government reserves the right in public interest to make any amendments to the trade Policy in exercise of the powers conferred by Section-5 of the Act. Such amendment shall be made by means of a Notification published in the Gazette of India. Prior to 2004, the Foreign Trade Policy was called EXIM Policy. The Foreign Trade Policy, 2015-2020 (FTP) was finally announced by the Hon„ble Minister of Commerce and Industry, Smt. Nirmala Sitharaman on April 1, 2015. The FTP has been announced in the backdrop of several measures initiated by the Government of India such as “Make in India”, “Digital India” and

“Skills India” among others.

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3. THEORY OF TRADE OPENNESS AND ECONOMIC GROWTH

India had a relatively open trade regime until the 1950s with low tariff rates; quantitative import restrictions were not onerous and there was no evidence of foreign-exchange controls. The foreign exchange crisis in 1957 led to imposition of quantitative restrictions on imports, industrial licensing and foreign exchange controls, and these were progressively increased until 1966. The Ministry of Finance prioritized the usage of available foreign exchange. An array of licensing agencies was involved in the allocation process of foreign exchange. Imports of raw materials were not permitted if domestic substitutes were available. The Government of India introduced export subsidization schemes in 1962 but they were not very successful in boosting exports. One of the disadvantages of the requirement that domestically produced inputs be used when available was that Indian exporters were compelled to use inferior-quality domestic inputs and therefore could not compete with their international counterparts.

India went through a phase of economic liberalization during 1966-68 which included measures such as the devaluation of the rupee by 57.5 per cent, removal of some import licensing controls and cuts in import tariffs. The measures were unpopular because of the widespread belief that they were in response to the dictates of the World Bank and the liberalization process was soon reversed and the protectionist regime continued until the 1970s (Panagariya, 2004). India‟s trade share (as percentage of GDP) went on falling continuously from late 1950s till 1970.India undertook several liberalizing steps such partial liberalization of imports during the 1980s mainly to allow a more liberal flow of essential raw materials and machinery. It also expanded domestic demand through fiscal stimuli supported by large deficits. Consequently, India achieved a growth rate of above 5 per cent during the 1980s, though it also increased its foreign and domestic debt to unsustainable levels. The result was a major macroeconomic crisis in 1991, which prompted serious economic reforms including a systematic liberalization of trade. Within a decade, import licensing was entirely abolished and the highest tariff rate was brought down from 355 per cent to about 30 per cent (Bhat, 2011; Mukherjee and Mukherjee, 2012). Consequently, India experienced a sharp rise in its trade openness.

Broadly speaking, there are three sources of economic growth- factor accumulation, increase in productivity and innovation (Srinivasan, 2001). Trade openness can potentially enhance the growth prospects of a country by influencing any of these three sources of growth. For instance, an open economy can obtain factors (or their services) more easily from abroad compared to a closed economy. Trade openness also leads to better allocation of resources. When an economy opens up, forces of comparative advantage forces the economy to specialize in the sector for which it has better factor endowments. As a result, productivity of that sector goes up. The exports from that sector also increase which consequently boosts growth. Lastly, trade openness also encourages technology transfer from developed to developing economies which leads to an increase in factor productivity and finally enhances growth (Romer, 1991 and Chuang, 2000).

The traditional models of international trade discuss how trade openness improves the allocation of resources thus leading to an increase in production. The Ricardian Model says that trade liberalization makes an economy specialize in the sector where it has a comparative advantage. This, in turn, leads to an increase in production of output and makes the country better off. The Heckscher-Ohlin Model shows that if two economies have different resources (i.e. one is more labour-intensive and the other more capital-intensive) then opening up to trade can lead to higher output (thus, higher incomes) in both the economies. That is because each economy specializes in the sector which uses its abundant factor more intensively in the H-O model. In some “new” trade theories (such as Krugman, 1979) also, the total output goes up as a country liberalizes its trade.

However, in the growth theories, the impact of trade openness on the rate of economic growth is not very unambiguous (Lopez, 2005). For example, in the neoclassical growth models such as the Solow model, the steady-state rate of output growth is exogenous. One explanation for why a change in policies (initiating trade reforms, for example) will not bring a change in the steady-state growth rate in the neoclassical models is because of the assumption that the marginal product of capital declines to zero as the capital-labour ratio increases indefinitely. The new growth theories or the endogenous

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growth theories do recognize trade openness as one of the primary engines of growth (Romer, 1990 and Lucas, 1998).

However, the new growth theories do not presume that trade openness will unambiguously promote economic growth (Harrison, 1991). When a closed economy opens up, the forces of comparative advantage can either promote primary sectors or technology and high-skill intensive sectors depending on the initial factor endowments of the economy.

If an economy is technologically backward then trade liberalization is most likely to encourage the economy to specialize in primary or low-skilled sectors and discourage the development of its high-skilled sectors which may ultimately have an adverse effect on its long run growth rate (Grossman and Helpman, 1991).

Growth after trade liberalization depends on whether the liberalization is encouraging R&D and innovation or not. However, sometimes increased competition from trade liberalization can discourage innovation by lowering expected profits. On the other hand, protectionism can facilitate long-run growth if protectionism encourages investment in research-intensive sectors (Grossman and Helpman, 1992). Furthermore, whether trade openness will accelerate growth or not depends on a large number of other factors such as macroeconomic stability and investment in physical and social infrastructure (Panagariya, 2003). In short, the theoretical literature cannot provide an unambiguous answer to the question of trade and growth.

4. TRADE POLICY REFORM IN 1991

In 1991, India‟s foreign exchange reserves had plummeted to levels which would finance only afortnight‟s imports, the debt service burden was one-fifth of current account receipts, fiscal deficit was above 8 per cent, leading to pressure on balance of payments, and the consumer price index had increased by 13.6 per cent with implications for changing the foreign exchange rate. Those were dire times which required major policy changes. The 1991 Union Budget recognised the significance of trade policy reform as part of the overall reform programme, stating for instance that: “The policies for industrial development are intimately related to policies for trade. A number of steps were taken to reform trade policy:

a more outward oriented regime was put in place, tariffs were reduced in a phased manner, import duties were streamlined or simplified, and a process transforming quantitative border restrictions to price based measures was begun.

Likewise, export incentives were continued or new ones provided for a number of products, and institutional changes were made to bring transparency and to facilitate transactions involving domestic and foreign markets. This included the establishment of certain institutions or revised mandate for existing institutions that would help implement the new focus areas (e.g., the Tariff Commission).The1991 Union Budget speech gives the main thrust of policy change as follows: “The time has come to expose Indian industry to competition from abroad in a phased manner. As a first step in this direction, the government has introduced changes in import export policy; aimed at are duction of import licensing, vigorous export promotion and optimal import compression. The exchange rate adjustments on July 1 and 3, 1991 and the enlargement and liberalisation of the replenishment licence system constitute the two major initial steps in the direction of trade policy reform. They represent the beginning of a transition from a regime of quantitative restrictions to a price based mechanism.”

The 1991 trade policy reform was an exercise that balanced several objectives. For instance, loss of revenue was a major concern, and this was mentioned as a reason for not reducing the import duty more than was being announced. In a number of instances, import tariffs were kept high to encourage infant industry. The need for protecting Indian industry against foreign competition, and to save foreign exchange, were explicitly recognised. This was balanced with a reduction in tariffs to lower input costs and to encourage export activities. Interestingly, while a major part of the budget was oriented towards reform, much of it was conventionally focusing on certain ongoing objectives emphasised by the government and promoted through the budget, such as promoting technological up gradation, facilitating capital goods imports, keeping prices low for products such as essential drugs and certain machinery and equipment, improving the environment, promoting tourism by facilitating products that contribute to the value chain, and promoting software exports.

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Three interesting features emerge from the 1991 Union Budget. One, though the tariff levels were reduced, they were still kept at significantly high levels. Two, the trade policy reform in 1991was an initial step, which would be continued over time. Three, the nature and pace of reform would depend on the underlying economic factors which were a matter of concern for the Government. The trade policy reforms were notified by the Five- Year Expert-Import (EXIM) Policy in 1992, which provided stability to the content and direction of change brought in by the1991 reform. Another important feature of the 1991 reform was that it began opening up the regime for FDI. While FDI was not linked at that time with trade policy, it created a base for increasing economic linkages with global markets. We consider below how this objective of greater links with world markets was implemented through changes in tariffs and non-tariff measures.

5. INDIA’S CURRENT SCENARIO

The integration of the domestic economy through the twin channels of trade and capital flows has accelerated in the past two decades which in turn led to the India‟s GDP reaching Rs 167.73 trillion (US$ 2.30 trillion) in 2017-18. Simultaneously, the per capita income also nearly trebled during these years. India‟s trade and external sector had a significant impact on the GDP growth as well as expansion in per capita income. Provisional estimates of India‟s GDP during the 2018-19 stood at Rs 190.10 trillion (US$ 2.72 trillion). As per the estimates of Gross Domestic Product (GDP) for the first quarter (Q1) of 2019-20, the growth of real GDP for Q1 of 2019-20 is estimated at 5 percent. Total exports from India (Merchandise and Services) registered a growth of 1.60 per cent year-on-year during April- November 2019 to US$ 353.96 billion, while total imports estimated to be US$ 408.02 billion, exhibiting a negative growth of 5.30 per cent according to data from the Ministry of Commerce & Industry. Total exports from India (Merchandise and Services) registered a growth of 1.60 per cent year-on-year during April-November 2019 to US$ 353.96 billion, while total imports estimated to be US$ 408.02 billion, exhibiting a negative growth of 5.30 per cent according to data from the Ministry of Commerce & Industry. The merchandise export stood at Rs 14,89,793.87 crore (US$ 211.93 billion) during April-November 2019 and imports reaching Rs 22,39,900.18 crore (US$ 318.78 billion) for the same period. The estimated value of services export for April-October 2019 stood at US$ 142.02 billion and import is US$ 89.24 billion.

Thus, the overall trade deficit for April-November 2019 is estimated at US$ 54.06 billion. According to Mr Piyush Goyal, Minister for Commerce and Industry, the Government of India is keen to grow exports and provide more jobs for the young, talented, well-educated and even semi-skilled and unskilled workforce of India. India's foreign exchange reserves were Rs 32.19 lakh crore (US$ 460.65 billion) in the week up to November 22, 2019 according to data from the RBI.

A) Foreign Trade Policy (FTP) Highlights

 In the Mid-Term Review of the Foreign Trade Policy (FTP) 2015-20 the Ministry of Commerce and Industry has enhanced the scope of Merchandise Exports from India Scheme (MEIS) and Service Exports from India Scheme (SEIS), increased MEIS incentive raised for ready-made garments and made- ups by 2 per cent, raised SEIS incentive by 2 per cent and increased the validity of Duty Credit Scrips from 18 months to 24 months.

 In August 2019, Ministry of Commerce plans to introduce new foreign trade policy aimed at providing incentives and guidelines for increasing export in next five financial years 2020-25.

 As of December 2018, Government of India is planning to set up trade promotion bodies in 15 countries to boost exports from Small and Medium Enterprises (SME) in India.

 In September 2018, Government of India increased the duty incentives for 28 milk items under the Merchandise Export from India Scheme (MEIS).

 All export and import-related activities are governed by the Foreign Trade Policy (FTP), which is aimed at enhancing the country's exports and use trade expansion as an effective instrument of economic growth and employment generation.

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 The Department of Commerce has announced increased support for export of various products and included some additional items under the Merchandise Exports from India Scheme (MEIS) in order to help exporters to overcome the challenges faced by them.

 The Central Board of Excise and Customs (CBEC) has developed an 'integrated declaration' process leading to the creation of a single window which will provide the importers and exporters a single point interface for customs clearance of import and export goods.

 As part of the FTP strategy of market expansion, India has signed a Comprehensive Economic Partnership Agreement with South Korea which will provide enhanced market access to Indian exports. These trade agreements are in line with India‟s Look East Policy. To upgrade export sector infrastructure, „Towns of Export Excellence‟ and units located therein will be granted additional focused support and incentives.

 RBI has simplified the rules for credit to exporters, through which they can now get long-term advance from banks for up to 10 years to service their contracts. This measure will help exporters get into long-term contracts while aiding the overall export performance.

 The Government of India is expected to announce an interest subsidy scheme for exporters in order to boost exports and explore new markets.

B) Global Presence

India‟s share in global trade (merchandise and services) was 2.1% (481.74 USD billion out of total 23,044 USD billion) for exports and 2.6% (600.62 USD billion out of total 23,112 USD billion) for imports in 2017. Exports have been growing on a regular basis since 2016- 17 for almost three years and total exports reached a new peak of more than half a trillion dollars, for the first time in 2018-19. IMF in its World Economic Outlook (WEO) released in April 2015 has projected economic growth rate for 2015 and 2016 to be at 3.5%and 3.8%

respectively.

The new Foreign Trade Policy will focus on ways to boost India„s exports and reduce dependence on imports, a government official said on Monday. India being part of WTO cannot only think in terms its export promotion without equally supporting import substitution. Therefore, the focus of the new policy would be to vigorously promote both exports and imports with significantly substantial focus on exports as per the FTP 2015- 20.Old procedures and regulations governing exporters are trying to minimise and full support is being given for export promotion activities to have 5 per cent share in global trade and generation of employment opportunities in Indian Economy.

6. ABRIEF SURVEY OFLITERATURE

There are various reasons for countries to engage themselves in international trade and motives to expand their exports and imports are unassumingly gains from trade. The nations look forward to benefit from their complement relativity in production and thus the theory of Economist David Ricardo applies impeccably eventually corroborating that nations import and exports have extraordinary correlation with the methods of producing in a relatively better way. Economies of scale in production might be another reason for countries to try to determine for openness in the world global market. Both of these intentions majorly mirror the real world pattern of International commerce and flourishing trade openness (Krugman and Obsfield, 2006).

Mentioning earlier theories of trade, a special reference of Haberler (1936), Viner (1937), Mundell (1960),Bhagwati (1963), and Schumpeter (1954) is crucial to determine the survey based study on International trade carried out by the Neo-classical Economists. The classical Economists have very distinctly provided theories on Trade and Adam Smith (1776), J.S Mills (1917) have stipulated literatures on the basis of which the International trade theories have evolved. Eventually the Neo-classical Economists have rested their observations and findings on opportunity costs and indifference curve, A.P Lemer (1953), Meade (1955) and Haberler (1955), whereas the modem concepts restsupon factor endowment concepts reviewed and surveyed by Heckscher (1919) and Ohlin (1933).

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Hammouda, Jallab (2011) examined the relationship between trade liberalization, trade openness and growth alone, but their research can be enriched by comparing the development experiences of Africa and Asia. According to his conclusions forthcoming opinion should turn towards exploration for optimal amalgamations between liberalization and control in order to stimulate growth and intensify the competitiveness of developing economies. Marelli et al. (2011) use the 2SLS, Fixed Effects, Instrumental Variable Approach in the case of China and India to analysis the association between economic growth and trade openness. They show the positive impact of trade openness on economic growth. In contrast few theoretical and empirical studies are stated that trade openness impedes economic growth.

Chuhdhary et al (2010) studied the relationship between trade liberalization leading to trade openness and economic growth in India by Granger causality test. Results of this study disclosed that in long run liaison between growth of human capital and trade liberalization is noteworthy and affirmative although in short run labor force also ominously contribute to growth. Mitra, Pradeep K, (2009) studied Criticisms of the neoclassical model include the fact that the prediction of convergence fails for poorer countries (some have grown extremely rapidly, while others have experienced absolute declines in living standards), and that the rate of technological change is influenced by recognizable economic factors. Thus, in the last decade or so endogenous growth theories have emerged.

There are many varieties of endogenous growth theory, emphasizing variously R&D spending, human capital, leaming-by-doing, technological spillovers, and the underlying technology of production.

Dash (2009) tested export-led growth hypothesis in India by using the data 1991-Q1 to 2007-Q4. He found a long run relationship among export and output, and unidirectional causality from export to economic growth. He recommends further trade openness in order to sustain the long economic growth. Andesen and Babula (2008), have found a link between trade openness and long run economic growth of countries. They have evaluated the most quoted rational probes of the affiliation between worldwide trade and economic growth and more realistic evaluates of the linkage amongst trade and efficiency/productivity growth. Vedpal et al. (2007) examine the relationship between trade openness and economic growth in the case of India by using the real import, export, and import plus export as an indicator of trade openness. They found bidirectional causality among economic growth and trade openness indicators, and recommends a higher level of trade openness enhances the economic growth.

Chen and Gupta (2006) have argued and proved that International trade openness create knowledge spillovers, augments productivity and improves human capital. This will help economies to continually grow and will help to provide the production units in an economy, increasing returns to scale respectively. Wacziarg (2001) examined the link between trade policy and GDP growth in the case of 57 countries4. He used three trade policy indicators, i.e. tariff barrier, non-tariff barriers and a dummy variable is included in the model for trade liberalization status. He concludes positive link among trade openness and GDP growth. Srinivansan (1999) gave examples of early growth models where trade liberalization resulted into effective increase in exports and imports of a nation which in turn led to elevated trade openness. Hedrew conclusions from the old Harrod-Domar Model, where effective trade openness resulted into effective rate of growth in a developing Economy.

7. OVERVIEW OF THE VARIABLES (DATA) USED

The sum of export and import as a percentage of GDP is used as a measure of trade liberalization (hereafter TO), while the Growth rate of real per capita GDP is used as the indicator of economic growth (hereafter GR) for the period 1971-2018. Data used in this study are published and unpublished. Published data are available from various RBI publications (Currency and Finance), Economic Survey, World Development Indicators (World Bank), IFS (IMF); Handbook of Statistics, OECD data base different issues, Government of India.

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9 8. MODEL SPECIFICATION

In our empirical study log-linear specifications of the variables are used and to the following estimation equation as:

In GR= β0 + β1In TO + εt where:

GR and TO represents economic growth and trade openness respectively. β1 contribute for the elasticity of the explanatory variables.

9. RESEARCH METHODOLOGY

This study investigates the relationship among the international trade and economic growth by using time series econometric methodology. To this aim first Augmented Dickey Fuller tests (ADF) Phillips-Perron (PP) unit root tests to confirm the stationarity of the variables.

Then Johnsen and Juselius (1990) co-integration is employed to investigate the cointegration association between financial development, international trade openness and economic growth with the variables as GDP and the explanatory variables. Furthermore, to determine the direction of causality between the variables, the research study has employed the granger causality test.

A) Test for order of integration 1. Stationarity Tests

Before the testing for a causal relationship between the time series, the first step is to check the stationarity of the variables used in the model to be estimated. The aim is to verify whether a series stationary or non-stationary and to identify the order of integration of the variables used in the model. The importance of stationarity feature of the series is that the impact of shocks to a stationary time series dissipates in the long run. The identification of the order of integrated ness of a series helps to avoid estimation of spurious regressions. A time series is said to be strictly stationary, if the joint distribution of Xt1 , Xt2 ,… ,Xtn is the same as the joint distribution of Xt1+τ,Xt2+τ,...,Xtn+τ for all t1, t2,… ,tn, and τ. The distribution of the stationary process remains unchanged when shifted in time by an arbitrary value τ.

Thus the parameters which characterize the distribution of the process do not depend on t, but on the lag τ. The mean and variance of Xt are constant and the covariances of Xt

depend only on the lag or difference τ = t1- t2, not on t1 or t2. A) Unit Root Test

Augmented Dickey-Fuller (ADF) test is based on independently and identically distributed (iid) errors. In the following discussions, we have briefly touched upon the specification of a unit root process based on Enders (2004) and Brooks (2008). The basic objective of the test is to examine the null hypothesis that the series Yt contains a unit root, i.e., ϕ=1. Suppose we are given an AR(1) process, as specified in equation.

Yt = ϕYt-1+ut -1≤ ϕ≤1 (1)

where ut is a white noise error term. If ϕ=1, that is, in the case of a unit root, equation (1) becomes a random walk model without drift, which is a non-stationary stochastic process.

Thus, the null hypothesis or H0 is: “Series Yt contains a unit root” versus alternative hypothesis “H1: Yt series is stationary”.

Subtracting Yt-1 from both the sides of equation (1), we obtain equation (2) or (2a) as follows.

Yt-Yt-1 =ϕYt-1-Yt-1+ut (2)

=(ϕ-1)Yt-1+ut (2a)

Equation (2a) can be alternatively written as equation (3) as

ΔYt=δYt-1+u (3)

Where δ=(ϕ-1) and Δ as usual is the first difference operator. This transformation of coefficients from ϕ to δ enables us to test the hypothesis as to whether the coefficient of Yt-1 is statistically significantly different from zero or not.

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The Augmented Dickey-Fuller (ADF) tests here consist of estimating the regression equation.

∆Yt =α0 +δYt-1+∑pi=2βi ∆Yt-i+1+ut (4) where δ=-(1-∑pi=1αi

βi =∑_pj=iαj

ut is a pure white noise term.

∆Yt-1=(Yt-1-Yt-2), ∆Yt-2=(Yt-2-Yt-3), and so on. The number of lagged difference terms to include is often determined empirically, the idea being to include enough terms so that the error term is serially uncorrelated.

Secondly we used the Phillips-Perron (PP) unit root test for empirical analysis. The order of integration of the selected variables has to be investigated to check whether series are stationary. The null hypothesis for PP test is that series has unit root. If the PP series is non-stationary at level, the PP series should be taken in order of first difference to make the series stationary. pp stationary series at the level donated by I (0) and pp stationary series at the first differences donated by I (1). The unit roots tests should be started from the most general models such as trend and intercept (Enders, 1995).

The estimation equation can be written as follows;

Where:

Y, t, a, εt, and P are variables used which is refers to the dependent variable, trend, intercept, Gaussian white noise and the lag level respectively.

B) Johansen's Co-integration Test

To analyse the long-run link between two variables such as trade openness and economic growth and confirm they are stationary at first difference, the results in the Table 1 and 2 indicates that according to the ADF and PP procedures variables have the same order of integration I(1). The next step is to investigate the long-run co-integration equilibrium relationship between variables. We have used Johansen, 1988 model to test the cointegration. Johansen test help to identify the long-run association among variables.

The Johansen methodology can be written equation as follows;

where:

Xt, Xt-1, and Xt-k are vectors of level and lagged values of the variables respectively which is integrated order of I(1); ,…, are coefficient matrices with (PXP)dimensions. are intercept vector and vector of random error (Katircioglu et al., 2007).

C) Granger Causality Test

In third step, after determining existence of co-integration relationship (Katircioglu et al.,2007) then causality must exist either unidirectionally or bidirectionally. Further step is to investigate the time series data test for the direction of causation purpose we have use dgranger causality method as proposed by granger (1988). Furthermore, asemphasized in granger (1988) both the relationship between co-integration and granger causality is estimated.

Granger (1988) suggests the following equation of causality model;

where:

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bj is statistically significant; Yt Granger causes Zt. However if Cj is different than zero; Zt Granger causes Ytrespectively.

10. EMPIRICAL ANALYSIS

Table No.1 Unit root test results for Log Gross Domestic Product LGDP

Values ADF Test Conclusion PP Test Conclusion

t-statistic -6.90109 I(1) -6.90109 I(1)

Test critical

values

1% level -3.59246 -3.59246

5% level -2.93140 -2.93140

10% level -2.60394 -2.60394

Durbin- Watson

statistic 1.938672 1.938672

Source: Calculated with the help of Eview 7

*MacKinnon‟s (MacKinnon, 1991) tabulated value has been used to test the level of significance. I (1): Integrated of order one

Table No.2 Unit root test results for Log Trade Openness LTRADEOPEN

Values ADF

Test Conclusion PP Test Conclusion

t-statistic -4.35632 I(1) -4.31072 I(1)

Test critical

values

1% level -3.58115 -3.58115

5% level -2.92662 -2.92662

10% level -2.60142 -2.60142

Durbin- Watson

statistic 1.43210 1.43210

*MacKinnon‟s (MacKinnon, 1991) tabulated value has been used to test the level of significance. I (1): Integrated of order one

While testing for ADF and PP we then determine the stationary nature of the variables. Table 1 and 2 present the results for ADF and PP unit root test. Both test indicates that all variables are found non-stationary at their level, null hypothesis is rejected and stationarity found at first difference which confirms that all variables are integrated order of first difference or I (1) level alternative hypothesis is accepted.

Table- 3 Co-integration results Date: 01/29/20 Time: 22:32

Sample (adjusted): 1975 2018

Included observations: 41 after adjustments

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Trend assumption: Linear deterministic trend Series: LGDP LTRADEOPEN

Lags interval (in first differences): 1 to 1 Unrestricted Cointegration Rank Test (Trace) Hypothesized

No. of CE(s) Eigenvalue Trace

Statistic 0.05

Critical Value Prob.**

None * 0.447164 24.30044 15.49471 0.0018

At most 1 * 3.59E-07 1.47E-05 3.841466 0.9991 Trace test indicates 1 cointegrating eqn(s) at the 0.05 level

* denotes rejection of the hypothesis at the 0.05 level **MacKinnon-Haug-Michelis (1999) p-values

Above table reports the long-run relationship from the Johansen cointegration estimation in order to evaluate the long-run association among the variables which are GDP per capita and trade openness indicators. Furthermore, in our proposed model of economic growth (Y) is a dependent variable while other is explanatory variable which is trade openness indicator. The evidence from Johansen cointegration estimated results shows that the trace statistic values is greater than (24.30044) their (15.49471) critical values at 0.05 level. And the value of Max-Eigen Statistic value (24.30043) is greater than Critical value (14.26460). Our proposed model indicates that if null hypothesis rejected then there is no co-integration between the variables, while accepted alternative hypothesis confirms that there is cointegration between the variables. Results show that there is a long-run equilibrium association between economic growth and trade liberalization in India.

Table- 4 Granger casualty results Pairwise Granger Causality Tests

Date: 01/29/20 Time: 22:33 Sample: 1971 2018

Lags: 4

Null Hypothesis: Obs F-Statistic Prob.

LTRADEOPEN does not Granger Cause LGDP 37 3.88098 0.0125 LGDP does not Granger Cause LTRADEOPEN 0.50626 0.7315 Source: Source: Calculated with the help of Eview 7

Table 4 provides results of Granger causality test after determining existence of long run link. To ensure that the empirical estimated values are in order as vertical values are independent variables and horizontal values are dependent variables, which is the lagged differenced coefficients of F statistical values which is determined as direction of short run Granger Causality runs from GDP to Trade Openness. In our proposed model, the null hypothesis indicates that there is non-causality between variables. If null hypothesis rejected then the model confirms that independent variables cause the dependent variables.

Unrestricted Cointegration Rank Test (Maximum Eigenvalue)

Hypothesized Max-Eigen 0.05

No. of CE(s) Eigenvalue Statistic Critical Value Prob.**

None * 0.447164 24.30043 14.26460 0.0010 At most 1 3.59E-07 1.47E-05 3.841466 0.9991 Max-eigenvalue test indicates 1 cointegrating eqn(s) at the 0.05 level * denotes rejection of the hypothesis at the 0.05 level

**MacKinnon-Haug-Michelis (1999) p-values

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-6 -4 -2 0 2 4 6 8 10

1975 1980 1985 1990 1995 2000 2005 2010 2015 GDP

From the above diagram-1 of GDP we can see that from 1971 to 1991 our growth rate changes very drastically from 9 to 2 per cent in 1975 to 1976 and even went negative also in 1979 year but after liberalization process started from 1991 onwards its always shows positive growth rate. We can say that Liberalization, Privatisation and Globalization (LPG) are good for Indian economy.

0 5 10 15 20 25 30 35 40 45

1975 1980 1985 1990 1995 2000 2005 2010 2015 TRADEOPEN

When we talk about trade openness policy of Indian economy and plot data in a graph form and see the trade liberalization from 1971 to 1991 is positive but contribution is not significant as a per cent of GDP. After LPG year 1991 its share in GDP is started getting pace and also reached even 40% in 2018. Though the per cent of import is much more than per cent of export but it‟s a good sing for the healthy economy and we must focus on the same in order to get 5 per cent targeted share global trade as per new FTP.

-10 0 10 20 30 40 50

1975 1980 1985 1990 1995 2000 2005 2010 2015 GDP TRADEOPEN

Diagram-3

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From the above diagram 3it is clear that the relationship between trade openness and GDP is very much relevant and beneficial for the development and both moving in the positive direction after 1991 onwards.

11. CONCLUSION AND POLICY IMPLICATIONS

The objective of the study is to explore the long run relationship and direction of causality between international trade openness and growth in Indian context. To this aim, first Phillips-Perron (PP) unit root tests were applied and at this level all the variables were non- stationary, which means that null hypothesis cannot be rejected. However, the stationarity found at their first difference of the series is significant. Next step was to analyse the cointegration relationship between the both variables by employing Johansen Test and found 1 cointerating vector, that there exists a long run relationship between international trade openness and growth. Furthermore, the direction of the causality was evaluated by Granger Causality method. Our Granger causality results show that causality follows from GDP to Trade Openness and support trade-led hypothesis.

Trade liberalization has been extremely prominent component of policy advice to an amazingly developing country like India during the last five decades. It may be asserted from the possibility that Economic Growth is perhaps the most imperative advantage originated from it. There can be another implication drawn from the study which prominently states that there has been improvement in exports and imports of our mighty nation after the series of structural reforms taken place during 1991.During 1971-1990 India was following export and import policies in a limited and controlled manner and its contrition in development was not up to the mark. Thus providing with a beneficial insight that globalization has improved after the trade liberalization which has in turn indorsed competition in home and global market and also stimulated proficient allotment of resources in the Economy.

Based on empirical analysis the study suggest following points for the economy, first, in India should focus more on export rather than imports and try to push corporates to make substitute products for imported goods at the reasonable prices. Secondly, for achieving good economic growth government needs to provide adequate money in the system for increasing aggregate demand and funds to the firms. Thirdly, to encourage the private sector by providing incentives for production, the total production of the economy will be increased which will promote international trade and which can take more active role in the development of the economy. Broadly study concludes that Indian Trade Liberalization policies have a positive impact on the economy and we should continually focus on the same. For achieving dream mark of $5 Trillion economy, India has to take several decisions as a process of trade reforms and follow FTP objective of getting 5 per cent share in global trade. Focus should be more on export rather than import and keeping exchange rate around 70 as per dollar.

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