Empirical Analysis of the Determinants of Trade Balance in Post-liberalization Ghana

Date01 August 2019
AuthorLinda Akoto,Daniel Sakyi
Publication Date01 August 2019
03_FTR851632.indd Article
Empirical Analysis
Foreign Trade Review
54(3) 177–205, 2019
of the Determinants
© 2019 Indian Institute of
Foreign Trade
of Trade Balance in
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DOI: 10.1177/0015732519851632
Linda Akoto1
Daniel Sakyi1
This study investigates the determinants of trade balance in post-liberalization
Ghana, covering the period 1984–2015. Specifically, we test the validity of the
Marshall-Lerner condition and the J-curve effect, and further assess the effect
of other macroeconomic variables including household consumption expendi-
ture, government consumption expenditure, foreign income, money supply and
domestic prices on trade balance. The bounds testing approach to cointegration
and the error correction model within a symmetric and asymmetric autoregres-
sive distributed lag (ARDL) framework is used for the estimation. Additionally,
to analyse the dynamic interactions of the variables included in the estimated
model, variance decomposition is applied. The results from both symmetric
and asymmetric specifications show the absence of the Marshall-Lerner condi-
tion and the J-curve effect. Further, the study finds that household consump-
tion expenditure, government consumption expenditure and domestic prices
are negative and significant in the long and short run, whereas foreign income
and money supply are positive and significant in the short run. Results from
the variance decomposition show that innovations in household consumption
expenditure highly contribute to the forecast error variance of the trade bal-
ance compared with other explanatory variables. A key finding of the study
suggests that depreciation of the Ghana cedi is not an appropriate step to help
in improving the country’s trade balance position.
1 Department of Economics, Kwame Nkrumah University of Science and Technology, Kumasi, Ghana.
Corresponding author:
Daniel Sakyi, Department of Economics, Kwame Nkrumah University of Science and Technology,
Private Mail Bag, Kumasi, Ghana.
E-mail: dsakyi.cass@knust.edu.gh

Foreign Trade Review 54(3)
JEL Codes: C22, F10, F31, F32
Trade balance, Marshall-Lerner condition, J-curve effect, cointegration, Ghana
International trade has, for years, remained a key driver of economic prosperity
of countries that are increasingly integrated into the global economy. It serves as
an important tool in boosting the economic and social performance of countries,
especially the developing ones (United Nations Conference on Trade and
Development [UNCTAD], 2005). These benefits can be viewed through various
channels, including economic growth and/or development, poverty reduction
and low inflation (Bhagwati & Srinivasan, 2002; Karam & Zaki, 2015; Kim &
Beladi, 2005; Lotfalipour, Montazeri, & Sedighi, 2013; Sakyi, Villaverde and
Maza, 2015). Notwithstanding, it is important to note that whether a country is
reaping the benefits of international trade or not can be viewed through its trade
balance position which when in deficit (surplus) is often viewed as detrimental
(beneficial) for an economy.
While many developed countries have deliberately harnessed the forces of
international trade to improve their trade balance position, many developing
countries though have embarked on various unilateral and multilateral trade pol-
icy reforms have made very little gains (Osoro, 2013; Shawa & Shen, 2013;
UNCTAD, 2005, 2013). Ghana is no exception to this group of countries that have
implemented several unilateral and multilateral trade policy reforms with the aim
of improving its trade balance position. Among these are the Economic Recovery
Programme (ERP); the Structural Adjustment Programme (SAP); the Free Zone
Act, 1995 (Act 504); African Growth and Opportunity Act (AGOA); and the
African, Caribbean and Pacific group of States and the European Union (ACP-EU)
Economic Partnership Agreements. Again, there have been various efforts to
actively improve the country’s trade balance position through the establishment of
the Ghana National Export Promotion Council (GEPC) and the Ghana Export
Trade Information Centre (GETIC).
Prior to the implementation of the reform programmes, an import substitution
industrialization policy aimed at reducing the country’s dependence on imports
was implemented. During this period, state-owned enterprises in various sectors
of the economy were established, ranging from agricultural to manufacturing
industries. The import substitution industrialization policy was, however, not sus-
tainable due to continual political instabilities, low levels of factor productivity
and gross economic mismanagement (Killick, 2010). It is not surprising that for
most periods during this era, economic performance including the position of the
trade balance (see Appendix A) was poor. Although the country recorded a 3-year
trade surplus for the years 1967 to 1969, this was not sustainable as, by 1971, it
experienced one of its largest trade deficits (Killick, 2010). As the Bank of

Akoto and Sakyi 179
Ghana (2008) and Sakyi (2011) observed, the story was not different during the
1970s and the early 1980s. These huge trade deficits coupled with other economic
imbalances experienced in the pre-liberalization era precipitated the launch of the
ERP in 1983 on the basis of liberal policy regime with the aim of addressing,
among others, the trade deficits experienced in the country (Rodrik, 1999).
Though there were early gains in Ghana’s trade balance position after ERP,
and, by 1986, the country recorded a trade surplus of 0.025 per cent of GDP,1 this
was not sustainable, as for most periods thereafter the country recorded deficits in
its trade balance position (see Appendix A). During the early 1990s, the country
experienced trade deficits of 0.42 per cent, 0.51 per cent and 0.58 per cent of GDP
in 1990, 1992 and 1993, respectively. This could be attributed to the twin external
shocks which hit the country in the early 1990s. These shocks resulted in an
increase in crude oil prices and the collapse of two major export commodities of
the country, namely cocoa and gold. Although during some periods after ERP
there were significant improvements in the country’s trade deficits, the trade bal-
ance position in most periods was poor as indicated earlier. For instance, between
2001 and 2003, there were significant improvements in the country’s trade bal-
ance position as deficits improved from 0.35 per cent of GDP in 2001 to 0.25 per
cent of GDP in 2003. This was as a result of the quick recovery in the prices of
cocoa and gold in the international market (Bank of Ghana, 2008). However,
Ghana experienced trade deficits of 0.42 per cent of GDP in 2004 and 0.57 per
cent of GDP in 2008. The story is not so different in recent times as the country
recorded deficits of 0.44 per cent, 0.28 per cent, 0.26 per cent, 0.32 per cent, 0.21
per cent and 0.18 per cent of GDP in 2010, 2011, 2012, 2013, 2014 and 2015,
respectively. It is evident that though the trade liberalization policies embedded in
the ERP were aimed at improving the country’s trade balance position, there have
been very limited results in that regard.
It is important to note that, despite the negative implications of persistent trade
deficits on the economic performance of countries, only a few studies (see
Bhattarai & Armah, 2005; Danquah, 2008; Iyke & Ho, 2017) have been devoted
to the determinants of trade balance in Ghana. However, these studies mainly
focused on the effect of the exchange rate on Ghana’s trade balance controlling
for only domestic and foreign incomes. We further note that virtually no attention
has been given to the impact of other relevant macroeconomic variables on
Ghana’s trade balance. Again, following the recent literature, another limitation
we deduce from Bhattarai and Armah (2005) and Danquah (2008) is their sole
focus on the symmetric impact of the exchange rate on the trade balance. In sup-
port, Bahmani-Oskooee and Bahmani (2015) and Bahmani-Oskooee and
Fariditavana (2015, 2016) argue that the relationship between trade balance and
exchange rate may be asymmetric. However, as per the literature reviewed, only
a few studies have considered both symmetric and asymmetric determinants of
trade balance.
Given that Ghana’s post-liberalization period has mostly been characterized by
trade deficits, the question worth investigating is what the key determinants of
these deficits are? To answer this question, this article provides an empirical test
of the Marshall-Lerner condition and the J-curve effect by investigating the effect

Foreign Trade Review 54(3)
of exchange rate movement on trade balance in Ghana. It further assesses the
effect of other macroeconomic variables including household consumption
expenditure, government consumption expenditure, foreign income, money sup-
ply and domestic prices on trade balance. Finally, we analyse the dynamic interac-
tions of the variables considered in the study.
The remainder of the article is structured as follows. The second section pre-
sents a survey on the determinants of trade balance. This is followed by the model,
data and the estimation methods in the third section. The fourth section reports the
empirical results and discussion. Finally, the fifth section is devoted to the impli-

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