Saving Investment Correlation in South Asia- A Panel Approach

Transcription

1 European Journal of Economcs, Fnance and Admnstratve Scences SSN ssue 11 (008) EuroJournals, nc Savng nvestment Correlaton n South Asa- A Panel Approach Abu N. M. Wahd Tennessee State Unversty, U.S.A E-mal: JDA@tnstate.edu Mohammad Salahuddn Southeast Unversty, Bangladesh Abdullah M. Noman Amercan nternatonal Unversty Bangladesh Abstract Usng Fxed Effect, Random Effect and between or CS models, we fnd that there s low correlaton between savng and nvestment n Bangladesh, nda, Pakstan, Srlanka and Nepal. However ths result does not necessarly mply hgh captal moblty n these countres as captal moblty s nfluenced by other factors also such as the economc sze, dfferences n fnancal structure across countres, fscal polcy coordnaton etc. Keywords: Savng-nvestment correlaton, panel data, F-H puzzle. JEL Classfcaton Codes: F1, F3, F41 1. ntroducton Understandng the savng-nvestment lnk s mportant for two reasons. Frst, t may hold the key to the postve correlaton between savng and growth and second, f captal accumulaton s mportant for growth, the nteracton between savng and nvestment s crucal for assessng the valdty of the vew that rasng savngs s the surest way to ncrease growth. Keynes well-known paradox of thrft accordng to whch, an ex-ante ncrease n savng may lead va multpler to an ex-post declne n real output, nvestment and savng tself nssts that polces to encourage savngs by rasng nvestment and growth mght n fact prove to be futle. Nevertheless, n closed economy, natonal savngs and domestc nvestment must be dentcal ex post but n an open economy that facltates unrestrcted captal moblty between countres, captal wll flow where t may yeld the hghest return from. An ncrease n savng would be reflected n current account rather than n hgher domestc nvestment and growth. Snce the ground-breakng semnal work of Fledsten and Horoka n 1980 on the relatonshp between savng and nvestment on 16 OECD countres where they found hgh savng nvestment correlaton and explaned t as an evdence of low captal moblty, several researchers nvestgated ths relatonshp. Some of the researchers supported ths puzzle whle others dsagreed on the ground that t s not the hgh savng-nvestment correlaton that determnes captal moblty between natons rather there are some other factors such as the economc sze, nternatonal fnancal lnkages fscal polcy coordnaton etc that may substantally explan captal moblty. The objectve of ths paper s to examne correlaton between savng and nvestment n some developng countres namely Bangladesh, Pakstan, nda, Nepal and Srlanka to see whether the fndngs match the common results of earler studes on other developng countres. To the best of our

2 154 European Journal of Economcs, Fnance And Admnstratve Scences - ssue 11 (008) knowledge, no study has so far been undertaken to examne savng nvestment correlaton n these countres. The rest of the paper s structured as follows; Secton dscusses lterature revew followed by dscusson on data and methodology n secton 3. Secton 4 reports the results. Secton 5 offers summary and conclusons.. Lterature Revew Snce the ground breakng work of Feldsten and Horoka n 1980, several researchers nvestgated the relatonshp between savng and nvestment. Although most research works focused on advanced economes, a few studes pad attenton to developng countres. Feldsten(1983) found that the hgh correlaton between savng and nvestment had not weakened over tme. Sachs(1981) proposed a modfcaton of the F-H model by ntroducng the current account as an ndcator of captal moblty and found that nvestment s more closely correlated wth changes n the current account than n savngs and that the correlaton s negatve. Capro and Howard (1984) on the other hand, found a strong assocaton between savngs and the current account. Other models showed that savng-nvestment correlaton s not the result of market mperfectons only, t may be due to other exogenous dsturbances. For example, Obstfeld s (1986a) lfe cycle model demonstrates that shocks to productvty generate co movements n savng and nvestment. n Fnn s (1990) model the, co movements stem from postvely autocorrelated domestc and foregn technology processes. McClure(1994) also explaned the S- assocaton manly n terms of the varance covarance structure of exogenous shocks. The emprcal lterature on F-H puzzle ncludes both cross-secton and tme seres nvestgatons. Dooley, Frankel and Matheson (1987) are the frst examples whose fndngs supported F-H puzzle. They examned 6 countres out of whch 48 were developng countres and 14 were OECD countres. They found that savng nvestment correlaton s hgher n OECD countres than n developng countres. They splt the sample nto two sub-perods, the fxed exchange rate perod and the floatng exchange rate perod. Ther fndngs also suggested that savng-nvestment correlaton s hgher durng floatng exchange rate perod for both OECD and developng countres. Bayoum (1990) found evdence of progressve lberalzaton of domestc fnancal markets and the dsmantlng of captal controls. Wong (1990) showed that the sze of non-traded sector can explan the hgh savng nvestment correlaton. Mamng (1994) nvestgated the F-H regresson usng tme seres estmaton for 58 developng countres. He also found that savng nvestment correlaton s much weaker for developng countres than for OECD countres. He argued that developng countres are usually small open economes where fscal polcy used for demand management purposes wll be unable to crowd out prvate sector nvestment. Snn(1996) nssted that usng decade averages leads to hgh savngnvestment correlaton. Krol (1996) argued that the F-H puzzle s related to estmaton technque and reported that lower estmates are obtaned by usng fxed effect panel regresson. Vamvakds and Waczarg (1998) found that the correlaton between savng and nvestment s lower or close to zero n a sample of developng countres. saksson (001) explan ths fndng by foregn ad. Ho (00) nssted that the power of estmaton technque matters as he found n a study on 0 OECD countres where he appled DOLS and FMOLS. There have been a number of studes that nvolved tme seres data. The frst one s due to Obstfeld (1986a) who consdered seven OECD countres and found that savng-nvestment correlaton dffered sgnfcantly from 1. A number of papers employed contegraton technques. Savngnvestment were found contegrated n a study on the U.S.A. by Mller(1988), by De Hann and Sermann (1994) for some OECD countres. Bayoum (1990) argued that to a large extent, the savng nvestment correlaton reflects endogenous nventory nvestment behavor. Hoffmann(1998) stressed that n ntertemporal optmzaton models of current account dynamcs, the budget constrant wll lead to hgh correlaton and hence contegraton between savng and nvestment.

3 155 European Journal of Economcs, Fnance And Admnstratve Scences - ssue 11 (008) Malng (1997) by usng FMOLS found that S- correlaton s generally lower n developng countres as compared to OECD countres. Hussen(1998) showed that captal s hghly moble n 18 OECD countres whle n 5 other countres, he found support for F-H puzzle. Monte Carlo technques were also used by some researchers. Jansen (1996) ndcated that the effect of ntertemporal budget constrant s strong enough to account for the F-H puzzle. Coakley et al. (1994, 1995ab and 1996) argued that t s smply a statstcal artfact of cross secton regresson. Usng panel data technques, they strongly rejected the null of non-statonary current balances whch mpled that savng and nvestment contegrate wth a unt coeffcent consstently wth ther tme-seres analyss. Sachsda and Caetano(000) provded an alternatve explanaton of the F-H puzzle based on domestc and external savngs substtutablty. Corbn(001) recognzed the mportance of controllng for the heterogenety of countres n a cross-secton analyss of the S- correlaton for a group of countres usng panel data. He concludes that hgh S- correlaton s more due to country specfc effect than to the exstence of common factors affectng all the countres n hs sample. Ho(003) augmented the emprcal lterature by examnng the threshold effect of country sze and got supportve evdence. Vta and Abott (001) found that there s hgh correlaton between savng and nvestment n the U.S.A. by applyng ARDL (Autoregressve Dstrbutve Lag) bounds testng. Ths correlaton however weakened durng the more lberalzed floatng exchange rate perod. Kasuga (004) employed cross sectonal analyss and concludes that the mpact of domestc savng on nvestment depended on fnancal systems and ther development. Usually n developng countres wth bank-based and /or relatvely neffcent fnancal sectors, the lower savng nvestment correlaton s not unexpected. Narayan (005) showed that low captal moblty also causes hgh savng nvestment correlaton n a study on Chna durng the perod of restrcted captal moblty as ndcated by low foregn drect nvestment (FD). Therefore a number of factors have emerged emprcally to explan the savng nvestment correlaton n both developed and developng countres. The fndngs of ths study wll be lmted to only savng nvestment correlaton and s not ntended to sngle out a factor that may substantally explan ths correlaton, be t hgh or low. 3. Data and Methodology Data Ths study ncludes panel data on nvestment and savngs for fve South Asan developng countres namely Bangladesh, Pakstan, nda, Nepal and Srlanka over the perod of 1973 to 00 compled from the World Development ndcator (WD) Database 004 CD-ROM. Snce the sample sze s small, to avod the loss of degrees of freedom we consdered yearly data for our study as has been the feature of many panel data studes these days. We calculated nvestment as a share of GDP (nvestment GDP rato) and domestc savngs as a share of GDP (savng GDP rato) to estmate our models. Panel data methods Let t be the (domestc) nvestment GDP rato of a country at tme t, and S t be the (domestc) savng GDP rato, then n an envronment of free captal moblty, one would expect very poor correlaton between these two varables n the followng regresson t = α + β St + ut, ut ~ d (0, σ ), = 1..., N, t = 1..., T (1) and the value of should approach zero. Equaton 1 s the baselne model and known as the Pooled OLS (POLS). Estmaton of pooled data usng smple OLS technque s however, sometmes nadequate. Ths gnores any country specfc effect that s unobservable. n other words, POLS mposes homogenety on both the ntercept and slope parameters. The fxed effect (FE) estmator, on the other

4 156 European Journal of Economcs, Fnance And Admnstratve Scences - ssue 11 (008) hand, allows heterogenety n the ntercept that accounts for country specfc effect by ntroducng dummy varables 1 as n the followng regresson t = α + β St + ut, ut ~ d(0, σ ) () whch s then estmated usng OLS method. Another closely related method that allows tme specfc heterogenety n addton to the country specfc heterogenety n the estmaton, s known as the two way fxed effect (FE) and can be formulated as follows t = α + α t + β St + ut, ut ~ d (0, σ ) (3) Ths paper also makes use of the random effect (RE) model where the ntercept represents the mean value of country specfc ntercepts as n the followng regresson t = α + β St + ut, ut ~ d (0, σ ) (4) where, α = α + ηα, where ηα ~ d (0, σ α ). For ths model to be approprate, t s further assumed that the dstrbuton of ntercept parameters are ndependent of the regressor, St and the error termu t. A major problem that relates to estmaton of panel data s the presence of cross secton dependence (CSD). Ths may arse due to effects of common unobservable and latent factors that affect all unts of a panel. We employ two partcular tests n order to detect the presence of CSD, these are Breusch and Pagan [BP] (1980) test and the Pesaran s (004) (PCD) test (descrbed below). Once the presence of CSD s detected n the data, t s desrable that the estmaton procedure takes ths nto account. n ths respect, we apply the between or the cross secton (CS) estmator = α + β S + u, u ~ d (0, σ ), = N (5) Pesaran and Smth (1995) showed that the CS estmator remans consstent n the presence of CSD gven that regressors and error loadngs are mutually ndependent. There are other estmators, however, that account for CSD, for example, the common correlated effects mean group (CMG) developed n Pesaran (006). But, ths method s more approprate for large heterogonous panel (wth N =15 or more) rather than small panel as n our case. Tests for cross secton dependence Breusch and Pagan (1980) proposed a smple Lagrange Multpler (LM) test to detect par wse correlaton. The test statstc s obtaned usng the followng formula CD lm = T N 1 N = 1 j= + 1 ˆ ρ j ρˆ j where s the sample par-wse correlaton of the resduals. BP show that under the null, the test statstc s asymptotcally dstrbuted as ch-squared wth N (N 1) degrees of freedom. However, one mportant condton s that we must have suffcently large T and small N. Another test whch s due to Pesaran (004) called PCD s conducted usng the followng formula N = 1 N T PCD ˆ ρj N( N 1) = 1 j= + 1 (7) The PCD statstc asymptotcally converges to the standard normal dstrbuton under the null of zero correlaton. The paper apples both of these two tests to check the presence of CSD (see appendx). (6) 1 Also known as the Least Square Dummy Varable (LSDV) method. Ths partcular approach s also equvalent to frst de meanng data and then applyng OLS. The orgnal Feldsten Horoka (1980) appled ths method to reach ther famous concluson of low captal moblty n a panel of OECD countres.

5 157 European Journal of Economcs, Fnance And Admnstratve Scences - ssue 11 (008) 4. Results We report results of four models, panel OLS(POLS) model, fxed effect model, random effect model and between or CS n table 1. All these models show that there s statstcally sgnfcant poor or low correlaton between savng and nvestment n Bangladesh, Pakstan, nda, Nepal and Srlanka. Estmaton of CS offers more relable results as cross sectonal dependence n the data s taken nto account. We see (from table 1A n appendx) that average correlaton s **. Both BP and LM test score s and PCD test statstc s rejectng the null of zero correlaton at all conventonal levels of sgnfcance. Table 1: Estmaton Results POLS Fxed Effect Random Effect Between or CS Savngs 0.54* 0.603* 0.594* 0.455** (0.047) (0.100) (0.05) (0.10) t stat ( β = 1 ) Constant 0.19* 0.119* * (0.007) (0.016) (0.095) (0.08) t stat ( α = 0 ) R DW Obs Notes: The Heteroscedastcty consstent standard errors n parentheses whch are obtaned usng the Whte s procedure.*(**) ndcate rejecton of the null at 1% and 5% level of sgnfcance respectvely. 5. Summary and Conclusons Many theoretcal and emprcal papers have attempted to explan savng nvestment correlaton n developng countres. n ths paper, we fnd that there exsts low postve correlaton between domestc savngs and nvestment n Bangladesh, Pakstan, nda, Nepal and Srlanka The fndngs should partally dsprove the Feldsten-Horoka puzzle. The poor savng nvestment correlaton does not necessarly mply hgh captal moblty n these countres snce t has been emprcally proved that low savng nvestment correlaton can be explaned also by a number of other factors such as economc sze(baxter and Crucn, 1993) dfferences n fnancal structure across countres (Kasuga, 003), foregn ad (saksson, 001), the sze of non-traded sector (Wong, 1990), poor fscal polcy (Mammng, 1994), swtchng from fxed exchange rate to more lberalzed flexble exchange rate perod (Dooley et al.,1987) country specfc effect (Corbn 001). Some of the authors even hold power of estmaton technque (Ho, 003), data averagng method (Snn, 1996) etc. responsble for hgh savng nvestment correlaton coeffcent. Fnally we conclude that Feldsten- Horoka puzzle stll remans a puzzle.

6 158 European Journal of Economcs, Fnance And Admnstratve Scences - ssue 11 (008) Appendx: Table 1A: Test for CSD Results Correlaton among the dsturbance terms from ndvdual regressons (OLS). Ban nd Nep Pak Sr Ban 1 nd 0.535* 1 Nep Pak Sr 0.648* 0.685* 0.394** 0.439** 1 Test Results Ave. Corr. 0.37** BP 5.95* PCD 6.40* * (**) rejects the null of no correlaton at 1% and 10% level of sgnfcance. BP stands for the Breusch Pagan test and PCD for the Pesaran s test for cross secton dependence (CSD). References 1] Baxter, M., & M. J. Crucn(1993), Explanng Savng-nvestment Correlatons, Amercan Economc Revew, 83, ] Bayoum, T., Savng- nvestment Correlatons: mmoble Captal, Government Polcy or Endogenous Behavour? MF Staff Papers, 37 (1990), ] Breusch, T. S. and Pagan, A. R. (1980). Spatal dependence n lnear regresson models wth an ntroducton to spatal econometrcs, n A. Ullah and D. E. A. Gles (Eds.), Handbook of Appled Economc Statstcs, New York: Marcel Dekker. Capro, G.A., Howard, D.H., (1984), Domestc savng, current accounts and nternatonal captal moblty. Board of Governors of the Federal Reserve System, nternatonal Fnance Dscusson Paper No ] Coakley, J., Kulas, F. and Smth, R. (1998), The Feldsten-Horoka Puzzle and Captal Moblty: A Revew, nternatonal Journal of Fnance and Economcs, 3: ] Corbn, A. (001), Country Specfc Effects n the Feldsten-Horoka paradox: A Panel Data Analyss, Economcs Letters, 7, ] de Haan, J. and Sermann, C. L. J.,(1994) Savng nvestment and Captal Moblty: A Comment on Leachman, Open Economes Revew, 5 (1994), ] De Vta, G. & A. Abott, (00), Are Savng and nvestment Contegrated? An ARDL Bounds Testng Approach, Economcs Letters, 77(), ] Dooley, M., Frankel, J. and Mathson, D. J., nternatonal Captal Moblty: What Do Savng- nvestment Correlatons Tell US? MF Staff Papers, 34(1987), ] Feldsten, M.(1983), Domestc savng and nternatonal captal movements n the long run and the short run, European Economc Revew, 1, ] Fnn, M.(1990), On Savng and nvestment Dynamcs n a Small Open Economy Journal of nternatonal Economcs, 9, ] Ho, T. W., (00), The Feldsten-Horoka puzzle Revsted, Journal of nternatonal Money and Fnance, ] Ho, T. W., (003), The Savng-Retenton Coeffcent and Country-sze: The Feldsten- Horoka puzzle Reconsdered, Journal of Macroeconomcs, 5(4), ] Hussen K., (1998), nternatonal Captal Moblty n OECD countres: The Feldsten- Horoka puzzle Revsted. Economcs Letters, 59, ] saksson, A., (001) Fnancal lberalzaton, foregn ad and captal moblty: evdence from 90 developng countres. Journal of nternatonal Fnancal Markets, nsttutons and Money 11,

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