A Comparison of Domestic Demand and Export-led Growth Strategies for European Transition Economies
| Date | 01 August 2018 |
| Published date | 01 August 2018 |
| Author | Yağmur Sağlam,Hüseyin Avni Egeli |
| DOI | 10.1177/0015732517734755 |
| Subject Matter | Articles |
A Comparison of
Foreign Trade Review
53(3) 156–173
Domestic Demand
©2018 Indian Institute of
Foreign Trade
and Export-led Growth
SAGE Publications
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Strategies for European
DOI: 10.1177/0015732517734755
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Transition Economies:
Dynamic Panel
Data Analysis
Yağmur Sağlam1
Hüseyin Avni Egeli1
Abstract
The relationship between growth and trade has been argued many times in the
literature. The topic is still current, dealing with different methodologies and
countries by researchers. In this frame to understand the relationship theoreti-
cally and empirically better, the topic is examined again with a different approach
which is explaining export-led growth (ELG) and domestic-demand-led growth
(DLG) strategies comparatively for European transition economies. The annual
data for the period between 1990 and 2015 were taken from Data Stream for 16
European (Central and Eastern Europe, Southeastern Europe and Balkans) transition
economies and because data include both cross section and time dimension, it is
necessary to apply dynamic panel data techniques. Second-generation unit root
test (multifactor), Westerlund ECM panel co-integration test and heterogene-
ous panel causality test are applied, and long-term coefficients are estimated
with common correlated effects (CCE) model. According to test results, not
only ELG but also DLG strategy is accepted for European transition econo-
mies, and the direction of the relationship between growth and trade is bilateral.
But the contribution of domestic demand on growth is seven times bigger than
net export. The leading countries for ELG strategy are Romania, Bosnia and
Herzegovina but for Poland and Czech Republic DLG strategy contributes more
on economic growth. It is a better macroeconomic policy to have the balance
1 Dokuz Eylul University, Department of Economics, Dokuzçeşmeler Campus, Buca-Izmir/Turkey.
Corresponding author:
Yağmur Sağlam, Dokuz Eylul University, Department of Economics, Dokuzçeşmeler Campus 35160,
Buca-Izmir/Turkey.
E-mail: yagmur.saglam@deu.edu.tr
Sağlam and Egeli 157
between export-led and domestic-demand-led growth strategies for a sustain-
able economic growth. The key approach of high growth rate is to produce high
technology with competitive price according to domestic demand and export it
to the foreigner markets.
JEL Codes: F14, C01, C33
Keywords
Export-led growth, domestic demand-led growth, dynamic panel data analysis,
transition economies
Introduction
It is known that there is a strong correlation between trade and growth but the
direction of the causality differs. If the direction of the relationship is from export
to growth, it is called export-led growth; domestic demand to growth it is called
domestic-demand-led growth and growth to trade it is called growth-driven trade
strategies. In addition, some studies claim that there is no relationship between
trade and growth or there is a feedback relationship between them. The question
asked in this study is, whether export-led growth strategy is better or domestic-
demand-led growth strategy is better for European transition economies? Or a
harmonious coexistence is possible?
The power of ELG strategy is coming from ‘trade not aid’ motto and it is
accepted the engine of economic growth because of three basic reasons. According
to Awokuse and Christopoulos (2009, p. 185):
1. Export is a direct activator for average out rate. If there is an increase on
foreign demand for export goods and services, it raises export revenue and
employment.
2. Export increases economic growth thanks to economies of scale, externali-
ties, efficient resource allocation and technological transfer.
3. Export increases capacity utilization rate cross countries via of developing
innovation and information functions. Also, it provides raw material for
intermediate goods, capital, allows to use energy as an input and creates
more supply for import. Also, the earnings from foreign exchange contribute
to economic growth.
In the literature, there are four different ELG models which explain why export
affect economic growth rate (Gandolfo, 1998: p. 212). Lamfalussy (1963) points
out the connection between investment (saving), trade and output rate for Western
Europe. Beckerman (1962) shows that demand is the key factor for growth and
foreign trade. Export is an important component of demand (Kaldor, 1970). There
are four requirements of growth: manufacturing, economies of scale (Verdoorn
Law), agriculture in the beginning of development and in the long-term export,
158
Foreign Trade Review 53(3)
play an important role for growth (Blecker, 2009, pp. 4–5). Thirlwall’s Law
(1979) explains cross country differences between factor productivity and supply
diversity.
ELG strategy was very successful between 1970 and 1996 for Japan and Asian
Tigers (Taiwan, Singapore, Hong Kong and South Korea) because of that
International Monetary Fund (IMF) recommended this strategy (de facto) as a
development model to 75 different countries including European Transition
Economies. According to World Bank (WB) country group statistics, Central
and Eastern Europe (CEE), Balkans and Southeastern Europe (SEE) are included
in European transition economies and does not consider Commonwealth Independent
States (Belarus, Ukraine, Russia, etc.) as one of them so in this study we focus
only these countries.
After the Berlin Wall fell down, on 9 November 1989, the countries declared
their political independence. Right after structural transformation, the social and
economical transformations have started. Transition economies abandoned com-
munism and followed liberalism instead. According to Blanchard and Plantes
(1977), the aim of these countries is to reveal the relative role of the non-tradable
sector and to use export as a transformation tool with efficiency. Because the
changes in the industrial structure and productivity help both export and eco-
nomic growth.
Many local development movements have begun after the political independ-
ence. Fundamental economic changes under gone by the countries are privatization
(state-owned enterprise has sold to foreigners through direct and indirect sales),
regulations on monetary policy, and credit and wage control policies. The government
tried to finance budget deficit with non-inflationary sources and switched to
flexible exchange rate.
Transition started with Poland in 1991 and followed by other reformers. First
10 years of macroeconomic indicators were good but fake. Later it is understood
that the chosen treatment strategy was not suitable for all countries.
According to Marangos (2002), the new layout of the transition process in the
system is powered by two different economical treatments.
1. Shock Treatment (also called Bigbang or Creative Destruction): The aim
of this method is to establish a free market economy, even if the deter-
mined legal framework of necessary reforms or the infrastructure is not
prepared yet. Privatization, price and trade liberalization are the main eco-
nomic tools to just to fulfil desires of international institutions (WB, WTO
and IMF) very quickly. The inevitable results are hyper-inflation, decline
in employment and output ratio, current payments deficit.
2. Neo-classic Gradual Treatment: Purpose of this method is to combine
market economy and democratic-political structure in the same pot. Each
implementation of laid down policy has to get approval of democratic-
political structure. In addition, the pace of reforms, political restructuring
and internal conditions differ from the shock treatment. The regulations are
mostly on commercial banking, market-oriented legal system and pensions
and unemployment system.
Sağlam and Egeli 159
CEE, Balkans and SEE countries have some common weaknesses like having
different openness rates and potential policy flexibilities. Also, sustainable
development has focused only ELG strategy which does not suit these countries’
production function. Catching up process is the main reason of polarization.
Traditional tax system and corporate income tax had crashed so the fiscal deficit
was inevitable. Therefore, human capital spending of government is limited.
Dutch Disease is common in countries with labour-intensive producing. Balkans
cannot catch up their structural and quantitative deficits by imitating the more
advanced CEE countries.
Transition process is not ergodic because of that overlapping with Post-Keynesian
Theory. The engine of the growth in a monetary economy is effective demand. Post-
Keynesian Theory says that the countries who preferred Neo-classic Gradual
Treatment instead of Shock Therapy was more successful (Marangos, 2001, p. 693).
Palley (2011) shows and criticizes that ELG strategy is not related anymore
with developing economies or changing structure in the countries because each
country has adopted that strategy according to their economic conditions. In addition
to this, the strategy was accepted by many countries at the same time so it turned
to a zero-sum game. The ELG strategy is based on foreigner demand so it caused
beggar-thy-neighbour problem with supply surplus and deflation. ELG strategy is
the reason not only low prices but also crowding-out between trading countries
(Palley, 2011, pp. 1–3).
Linder (1961) makes an important contribution to the international trade theory
and...
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