Acknowledgements First and foremost, I would like to thank God for providing me with the opportunities that I have

been granted and for giving me the greatest gifts of all, my wife, Niken, and our son, Rafi. Their unwavering love kept me strong through the difficulties of studying far away and alone in a foreign country. I would like to thank my parents, who have taught me the value of hard work and perseverance. I am deeply indebted to my advisor, Professor Yoichi Okita, for his constant guidance. Without his help, this paper would not have been completed. I would also like to give special thank for my program director, Professor Hideo Tanaka, for continuous encouragement during my work on this paper. Above all, I cannot express the full depth of my gratitude to the Japan-IMF for giving me the opportunity to study in Japan. I would also like to extend my appreciation to my home institution, the Directorate General of Taxes of the Ministry of Finance of Indonesia for giving me permission to study abroad. I also would like to thank to my fellow graduate students for their advice and help, especially Etjih Tasriah and Jassir Niti Samudro, who provided me with invaluable suggestions and insights in the development of this paper. Finally, I am thankful to all my friends who made my stay, at GRIPS in particular and in Japan in general, a memorable and valuable experience.

PRATOMO Mochammad Hadi (MET06080)

Abstract This paper reinvestigates the validity of the Export-Led Growth (ELG) hypothesis in Indonesia using annual data for the period 1980–2004. The conceptual model incorporates exports into a Cobb-Douglas production function and formulates dynamic econometric models for real gross domestic product (GDP), real exports, real gross fixed capital formation (GFCF), and labor force. This paper employs time-series econometrics techniques to test for the relationship and causal linkage between exports and economic growth. The obtained econometrics results are analyzed further with disaggregate analysis. Dynamic econometrics models are estimated to test for time-series properties: unit root test, lag length selection, cointegration test, and Granger causality test. The result of the econometrics techniques showed that unidirectional causality from economic growth to exports exists in Indonesia in both the short-run and the long-run. Hence, the ELG hypothesis is not applicable in Indonesia for the period of analysis. The results of disaggregate analysis indicated that lack of competitiveness and strategy seem to be the shortcomings of export performance. Keywords: Exports, economic growth, ELG hypothesis, cointegration, Granger causality, disaggregate analysis, export performance, Indonesia

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PRATOMO Mochammad Hadi (MET06080)

Abbreviations and Acronyms

ADF AFTA AIC APEC ASEAN BRICs COMTRADE DF ECM ELG FDI FPE FTA GDP GFCF GLE HPAEs HQ IDR IS IT ITC LR OLS OPEC PP SBC SIC UNSD USD VAR VAR-FD VAR-L WTO

Augmented Dickey-Fuller ASEAN Free Trade Area Akaike Information Criterion Asia-Pacific Economic Cooperation Association of SouthEast Asian Countries Brazil Russia India and China Common Format for Transient Data Exchange Dickey-Fuller Error Correction Model Export-Led Growth Foreign Direct Investment Final Prediction Error Free Trade Area Gross Domestic Product Gross Fixed Capital Formation Growth-Led Export High Performance Asian Economies Hannan-Quin Indonesia Rupiah (national currency of Indonesia) Import Substitution Information Technology International Trade Center Likelihood Ratio Ordinary Least Square Organization of the Petroleum-Exporting Countries Phillips-Perron Schwarz-Bayesian Criterion Schwarz Information Criterion United Nations Statistics Division United States Dollar Vector Autoregressive Vector Autoregressive in first-difference Vector Autoregressive in levels World Trade Organization

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PRATOMO Mochammad Hadi (MET06080)

Contents Acknowledgements ................................................................................................................ i Abstract ................................................................................................................................ ii Abbreviations and Acronyms ............................................................................................... iii Contents ............................................................................................................................... iv 1. Introduction....................................................................................................................... 1 2. Literature Review .............................................................................................................. 4 2.1. An Overview of Economic Growth and Exports in Indonesia ..................................... 4 2.2. Previous Research on Export Led Growth Hypothesis ................................................ 7 2.2.1. Cross-Section Analysis ........................................................................................ 8 2.2.2. Time-series Analysis ............................................................................................ 9 2.2.3. Related Empirical Studies on Exports and Economic Growth for Indonesia ....... 11 3. Methodology ................................................................................................................... 12 3.1. Theoretical Model .................................................................................................... 12 3.2. Econometric Methods ............................................................................................... 15 3.2.1. Unit Roots Tests ................................................................................................ 15 3.2.2. Lag Length Selection ......................................................................................... 17 3.2.3. Cointegration and Model Residual Analysis ....................................................... 19 3.2.4. Granger-Causality Tests ..................................................................................... 21 3.3. Disaggregate Analysis .............................................................................................. 25 4. Results and Discussion .................................................................................................... 26 4.1. Descriptive Statistics Analysis .................................................................................. 26 4.2. Econometric Analysis ............................................................................................... 28 4.2.1. Unit Root Tests .................................................................................................. 28 4.2.2. Lag Length Selection ......................................................................................... 29 4.2.3. Cointegration and Model Residual Analysis ....................................................... 29 4.2.4. Granger-Causality Tests ..................................................................................... 31 4.3. Disaggregate Analysis .............................................................................................. 32 5. Conclusions and Policy Implications ............................................................................... 36 References .......................................................................................................................... 39 Appendix A: Tables ............................................................................................................ 42

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PRATOMO Mochammad Hadi (MET06080) Appendix B: Figures ........................................................................................................... 51

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PRATOMO Mochammad Hadi (MET06080)

1. Introduction In recent years, much research interest has been focused on the role of exports as a major determinant of economic growth. The idea of ―export led growth hypothesis‖ (ELG) has gained further attention since the spectacular economic success of several East Asian countries. The economic arguments for ELG are that export expansion leads to better allocation of resources as a consequence of international competition and higher productivity. Furthermore, export expansion is expected to support economic development through the channel of positive externalities spillover from exports to economic growth. Therefore many developing countries in the world, including Indonesia, deliberately focus on boosting their export performance to support economic growth. The history of economic growth and exports in Indonesia is considered impressive by most economic indicators. Indonesia‘s economy experienced an average growth rate of 7% per year from 1967 through the mid-1990s. As a result, Indonesia‘s GDP achieved USD 202 billion in 1995, up from USD 26 billion in 1965. A similar pattern was observed on the export growth rate. The aggregate export values increased from USD 32 billion in 1980 to USD 78 billion in 2004, with an average growth rate of 9% per year. However, the degree to which exports bring about economic growth in economic development of a country has been controversial in the literature. Although there have been many empirical studies which emphasize a positive relationship between export and economic growth, the relationship between them remains a subject of debate. Some recent studies corroborated the existence of a causal relationship between exports and economic growth (Ghatak, Milner, & Utkulu, 1997; Rahman & Mustafa, 1997; Mah, 2005) while others cast some doubt on the validity of ELG hypothesis (Edwards, 1993; Shan & Tian, 1998; Richards, 2001).

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PRATOMO Mochammad Hadi (MET06080) Basically, the numerous empirical studies on ELG can be classified into those based on a cross-country data set and those based on a time-series data set (Shan & Sun, 1998). However, with the development of time-series techniques, an increasing number of ELG studies have sought to investigate the causality issues of different countries by employing timeseries techniques as opposed to cross-country data (i.e., Paul & Chowdhury, 1995; Ghatak et al., 1997; Richards, 2001). The main argument against cross-country data is that the theoretical framework used assumes a similar economic structure and production technology across countries, which is not accurate in the cases of most countries (Shan & Sun, 1998). Furthermore, cross-country data framework also neglects some important determinants of growth such as fiscal, monetary, and external policies (Edwards, 1993). Despite the abundance of ELG studies using time-series data, it should be noted that the empirical evidence on ELG for Indonesia has been mixed. Whereas some researchers reported results which supported ELG (i.e., Ram, 1987; Bahmani-Oskooee et al., 1991), others reported the opposite that economic growth led exports (i.e., Rahman & Mustafa, 1997), and another reported no correlation at all between exports and economic growth (i.e., Ahmad & Harnhirun, 1995). Given the ambiguity of the results of previous studies, this study is useful in order to establish further research on ELG hypothesis specifically for Indonesia. There are three main limitations of the previous ELG hypothesis studies of Indonesia that must be identified. First, those studies focused simply on causation between exports and economic growth without consideration of other relevant variables that may affect economic growth. Second, they conducted studies on too many countries, resulting in unfocused conclusions for each country rather than one, or a few, solid conclusion(s). Finally, a deeper analysis of the econometric results with the real performance of the analysis period‘s main variables was neglected.

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PRATOMO Mochammad Hadi (MET06080) In an effort to address these gaps, the general objective of this study is to empirically reinvestigate the ELG hypothesis for Indonesia for the period covering 1980 to 2004. These specific objectives are to: 1. Estimate dynamic time-series econometric models on the relationship between exports and economic growth by considering other relevant variables that affect economic growth based on neoclassical trade theory. 2. Test for a causal relationship between exports and economic growth. 3. Conduct a disaggregate analysis on the ELG hypothesis with the real exports performance data to obtain reliable conclusions. To conduct this study, time-series data for the 1980–2004 periods was collected from the World Development Indicators CD-ROM (World Bank [WB], 2006). The variables included in the analysis were real GDP, real aggregate exports, gross fixed capital formation (GFCF), and total labor force. All variables were deflated to 2000 constant USD, except for labor force, which measured in unit of labor. The time-series econometrics analyses were conducted with Eviews (version. 5.1) software. This paper is organized into five sections. Section 1 focuses on the development of the problem statement, justification, and objectives of the study. Section 2 describes an overview of Indonesia‘s economic conditions and various literature reviews as background for this study. Section 3 introduces the fundamental methodology used in this study including the selected economic theory and econometrics methods followed in conducting the study. Section 4 presents the results and interpretations of the analysis. Section 5 provides conclusions and implications of the analysis.

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PRATOMO Mochammad Hadi (MET06080) 2. Literature Review 2.1. An Overview of Economic Growth and Exports in Indonesia Economic growth in Indonesia was once considered successful by most economic indicators. The average economic growth rate of 7% per year and low inflation rates from 1967 to the mid-1990s, made Indonesia one of the high performance Asian economies (HPAEs) during that time, according to a 1993 World Bank report (Krugman & Obstfeld, 2006)1. Indonesia‘s GDP grew 7.7 times from USD 26 billion in 1965 to USD 202 billion in 1995, a remarkable growth rate. In the 1970s, the economy grew an average of 7.8%; in the 1980s, an average of 7%; and in 1990–1996, an average of 8% (Bresnan, 2005). The World Bank report identified several macroeconomic conditions which made Indonesia a part of the HPAEs. These were: conservative fiscal policies, prudent monetary policies, flexible exchange rate management, human capital investment, high savings rates, relatively limited price distortions, openness to foreign technology, a secure institutional environment for private investment, pragmatic outward-looking policies, and government intervention that encouraged rapid export growth. Woo, Glassburner, and Nasution (1994) identified four economic sub-periods in Indonesia between 1960 and 1990. These were the periods of: (1) guided economy (1960–1966); (2) stabilization and rehabilitation (1967–1972); (3) oil-fueled growth spurt (1973–1981); and, (4) external shocks (1983–1990). Each sub-period had a significant impact on Indonesia‘s dominant export composition.

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From a 1993 World Bank report, as cited by Krugman and Obstfeld (2006). World Bank defines HPAEs as a group of countries which achieved spectacular economic growth 1950–1990s. Indonesia with Malaysia and Thailand were categorized as newly industrialized economic countries (NIEC) which experienced rapid growth in late 1970s. Unfortunately during Asian financial crisis which started in 1997, most HPAEs were severely affected by crisis.

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PRATOMO Mochammad Hadi (MET06080) Rapid export growth began to rise quickly after the start of the ―New Order‖ era of the late 1960s2. Export performance began to grow in response to the rehabilitation of the traditional export sectors during the second sub-period which resulted in strong commodity performance. Moreover, the adoption of a realistic foreign exchange pricing policy (e.g., devaluation of the national currency) induced exporters to sell through legal channels. During the oil boom subperiod, as a member of Organization of the Petroleum-Exporting Countries (OPEC), Indonesia saw a dramatic increase in oil export revenues which sustained until 1984 when the nominal oil price started to plunge precipitously. Non-oil export commodity dominance, which was replaced by oil during the third sub-period, got back on track in the fourth sub-period with the manufacturing sector dominating exports composition3 (Hill, 2000). To maintain a positive balance-of-trade and to encourage export growth, especially after oil prices collapsed in the 1980s, the Indonesian government imposed reforms in the fiscal, monetary, investment, and trade areas. Fiscal and monetary reform was implemented by adjusting currency to favor exports, reactivating a stock exchange market and opening up a bond market, deregulating the banking and finance sectors, tax reform, and tax incentives for export commodities. Reforms in investment and trade were indicated by allowing 95% foreign ownership in export-oriented investments, a new export credit scheme, simplification and modernization of port administration, deregulation of export-import procedures, and tariff adjustments (Hakim, Rachbini, Aminullah, & Pitono, 1996). These efforts supported a macroeconomic environment that sustained Indonesia‘s high economic growth rate.

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The rise of the New Order succeeded the previous Soekarno (1945–1966) era. As cited by Hill (2000), late in the Soekarno era, Benjamin Higgins, the famous economist characterized Indonesia as the ―chronic dropout,‖ he concluded that ―Indonesia must surely be accounted the number one failure among the major underdeveloped countries‖, pp. 1. In line with Higgins statement, the chaotic situations caused by budgetary mismanagement and related policies gravely imperiled the Indonesia‘s economy, indicated by rejection by foreign investment, declining trade, hyperinflation (over 650 percent in 1965), and declining national income (Prawiro, 1998, pp. 6-8). All of these factors greatly contributed to the fall of Soekarno. 3 Indonesia‘s export by groups of product (in values and percentage share) during 1985–1997 is presented in Table 8 (Appendix A) and Figure 3 (Appendix B).

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PRATOMO Mochammad Hadi (MET06080) However, Indonesia‘s impressive economic performance had to end at some point, which came during the 1997 Asian financial crisis. The crisis, which began in Thailand, contracted the Indonesian economy by 13.6% in 1998 and made Indonesia the most seriously affected country involved. A 15.5% decline in per capita GDP in 1998 implied that the crisis cost Indonesia 3.5 years of growth (Hill, 1999). Furthermore, the crisis had a devastating socio-economic impact. The percentage of poor households grew from 11% in 1996 to 20% in 1999, formal wages dropped 34% in real terms between 1997 and 1998, and the exchange rate tumbled drastically from IDR 2,500 per 1 USD in mid-1997 to IDR 17,000 per 1 USD in January 1998. The inflation rate soared to 57.6% in 1998, from 8.8% in 1996 (Bresnan, 2005). The exports sector surprisingly showed a sharp decline in its major export performance despite enormous currency depreciation during the crisis. For example, non-oil exports fell sharply by 7.47% in 1998 and 4.33% in 1999 (Abdurohman & Zulfadin, 2002). Theoretically, as currency depreciation occurred, it should have been followed by strong export growth performance, such as that experienced in previous years. However, Abdurohman and Zulfadin argued that three problems emerged due to the poor performance of exports in periods of crisis: a sharp decline in the export commodities price due to the economic slowdown in destination countries, highly imported components content in export commodities, and an unstable political situation and banking crisis. In addition, the Indonesian corporate sector, as an export generator, was seriously damaged. In 1998, 58% of leading non-financial companies booked a net loss (Matsumoto, 2007). To overcome the crisis‘ severe impact, a new government in Indonesia4 undertook several measures to attempt to repair the macroeconomic situation: restructuring the banking sector, an aggressive process of state-owned enterprise privatization, fundamental fiscal decentralization,

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The impact of the crisis led to the fall of the Soeharto (New Order) regime. The crisis triggered the downfall together with acute socio-economic conditions such as rampant corruption, inefficient state-owned enterprise, imprudent banking management, and problematic foreign debt.

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PRATOMO Mochammad Hadi (MET06080) implementation of a floating exchange rate regime, and financial regulation reform (Hill, 2000). At the start of the millennium, there were signs of economic recovery. The economic growth average during 2000–2005 was 4.5%; 5.6% in 2006. The inflation and exchange rate were stable and fiscal deficit had fallen to less than 2% of GDP by 2000. On trade policy, there was further liberalization to dismantle protectionism although some significant unsupportive trade policies remained, particularly in the agricultural sector (Hill & Shiraishi, 2007). 2.2. Previous Research on Export Led Growth Hypothesis The idea of export expansion as a major determinant of economic growth has seen a recurrence of interest in economic literature. From the 1960s on, in developing countries (especially after the failure of import substitution (IS) strategy), export activities were widely considered a path to industrialization and an instrument that useful in boosting economic growth (Krugman & Obstfeld, 2006). Although it was assumed that export growth made a positive contribution to economic growth, this idea has remained controversial in the literature for the past two decades. Export expansion strategy gained popularity after the failure of IS strategy as a suitable trade strategy for developing countries. In the 1950s and 1960s, many Latin America and Asian countries, such as Chile, Peru, Argentina, India, and Pakistan, followed IS strategy. By the late 1960s, African countries such as Nigeria, Ethiopia, and Zambia began to pursue a similar strategy. However, after years of implementation, IS failed to act as an appropriate trade development strategy. IS was eventually replaced by an outwardlooking export promotion policy similar to that which the four Asian ―tiger‖ countries adopted (Todaro & Smith, 2006). During the past twenty years, in accordance with export promotion strategy, numerous empirical studies of causation of exports and economic growth have been conducted on the economies of developing countries, using either cross-section or time series analysis. Nevertheless, the empirical evidence has been rather mixed. While some studies supported a 7

PRATOMO Mochammad Hadi (MET06080) causal linkage between exports and economic growth, others failed to support the existence of a significant relationship between these two variables (Shan & Sun, 1998). 2.2.1. Cross-Section Analysis In the early cross-section analysis studies of this issue, the ELG hypothesis was tested by looking at rank correlation coefficients or simple association of ordinary least square (OLS) regressions between exports and growth and by estimating a regression equation where exports were included as an explanatory variable in classical inputs of production. According to rank correlation method, when the correlation coefficient between these two variables is positive and statistically significant, then ELG hypothesis is supported. The regressions equation approach, as a subsequent development of the rank correlation method, was conducted by estimating output growth regression equations against exports plus a set of explanatory variables based on neoclassical growth accounting techniques of production function 5. ELG hypothesis is supported when the coefficient of export variable is positive and statistically significant (Ekanayake, 1999). The major argument against cross-section analysis which employs rank correlation coefficient was that some of the results may involve a spurious regression based on the fact that exports were part of economic output6. Furthermore, these works also failed to consider the possibility of other factors besides exports roles on economic output. Finally, the issue of causality between exports and growth was not grounded on firm theoretical background (Edwards, 1993; Ghatak et al., 1997). Since spurious regression was a concern, the latter studies tried to incorporate a set of explanatory variables, including exports as endogenous variables, in their regression models to
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Giles & Williams (2000) documented more than 150 export-growth applied papers and grouped cross-section studies into rank correlation method or simple OLS regressions between export and growth and regression equation approach. 6 Spurious regression is regression with symptoms of having high R2, t-statistics that appear to be significant, but the results are without economic meaning (Enders, 2004).

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PRATOMO Mochammad Hadi (MET06080) capture the causality between exports and economic growth. By conducting this procedure, some scholars agreed there was evidence that developing countries with favorable exports expansion tended to experience a higher rate of economic growth. However, this method had limitations associated with the assumption that every country had similar economic conditions. Secondly, this methodology provided little insight for dynamic behavior in a particular country during certain periods. Finally, the assumption of no diminishing return on increased exports share had become a major criticism (Shirazi & Abdulmanap, 2005). 2.2.2. Time-series Analysis Considering the limitations of cross-section analysis, some studies of ELG hypothesis applied the time-series method to test the causality between exports and economic growth7. Among those analyses, there was a pattern of three commonly used steps: (1) test for unit roots in the series by applying Augmented Dickey-Fuller (ADF) test and/or Phillip Perron test; (2) test for cointegration using Johansen and/or Engle-Granger methods; and, (3) test for causality by employing Granger approach (Sinoha-Lopete, 2006). Some of the more recent studies also incorporated additional procedures by estimating vector autoregressive models (VAR) and/or by testing the structural VAR. Over the years, there have been numerous time-series studies investigating the causality between exports and growth on the basis of neoclassical production function. The information data set were tested in annual, quarterly, or monthly time bases. The following sections discuss four studies that employed time-series analysis on single developing countries in Asia. Ghatak et al. (1997) investigated the validity of ELG hypothesis for Malaysia using annual data from 1950 to 1990 for aggregated analysis. The variables included in the analysis were real

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The rapid development of time-series techniques made the analyses with this method more appropriate. Paul and Chowdhury (1995), Ghatak et al., (1997), Shan and Sun (1998), Zuniga (2005), Amrinto (2006), and Lopette (2006) are a few examples of works using modern time-series analysis.

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PRATOMO Mochammad Hadi (MET06080) GDP, non-export GDP, and exports. The authors tested for stationarity (ADF approach), cointegration (Engle-Granger), and Granger causality with error correction model (ECM) for cointegrated cases with constant. They concluded that ELG hypothesis was supported at aggregate level for real GDP and real non-export GDP. Mamun and Nath (2005) examined time-series evidence to investigate ELG hypothesis in Bangladesh using quarterly data from 1976 to 2003. The authors tested for unit roots with ADF test and lag length selected based on Akaike information criterion (AIC). The Engle-Granger cointegration test procedure was performed to investigate the existence of cointegration between export and economic output. ECM estimation was operated due to the existence of a cointegrating relationship and finally the Granger causality test was employed to examine short run causation between variables. The authors found that ELG hypothesis was supported in the long-run; however, there was no evidence of short-run causality between export and production function. Mah (2005) tested the ELG hypothesis for China using annual data from 1979 to 2001. The author tested for the existence of unit roots of real economic growth rate and export growth rate. Optimal lag length was selected based on Schwartz criterion and Engle-Granger procedure was employed to test for a cointegrating relationship between variables. Then, the author performed ECM due to the existence of a cointegrating relationship. Finally, the author found that bidirectional causality occurred between export expansion and economic growth in China. Amrinto (2006) implemented semiparametric approach under two levels of temporal aggregation to test the ELG hypothesis in the Philippines using annual and quarterly data from 1981 to 2004. Real GDP, real exports, real GFCF, and real effective exchange rate data were used as variables in the analysis. Unit roots test was performed with Phillips-Perron test and Engle-Granger procedure was operated for cointegration. Optimal lag length was determined using Schwartz Bayesian Criterion, and subsequently after ECM was built, the author

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PRATOMO Mochammad Hadi (MET06080) conducted the Granger causality test. The author found that bidirectional causality between exports and economic growth existed in the Philippines. 2.2.3. Related Empirical Studies on Exports and Economic Growth for Indonesia Empirical evidence on ELG hypothesis for Indonesia is mixed. Whereas some authors reported results supporting ELG, others reported growth-led exports (GLE), and still others reported no significant relationship between exports and economic growth8. Five articles with empirical evidence based on time-series analysis related to growth and exports in Indonesia are reviewed here. Ram (1987) conducted a cross-country study using data from 88 developing countries, including Indonesia, in various annual periods between 1960 and 1982. OLS regression method was employed to test ELG hypothesis on variables such as the growth rates of real GDP, population, real investment as share of output, and a dummy variable took into account the effects of the 1973 oil crisis. The author concluded that, in Indonesia‘s case, the result was statistically significant for export and economic growth. Bahmani-Oskooee, Mohtad, and Shabsigh (1991) tested the ELG hypothesis for 20 developing countries using annual data within from 1951 to 1987 (Indonesia was tested from 1960 to 1985). They employed the Granger causality test with Akaike final prediction error (FPE) to examine the variables of real GDP and export growth. The authors argued that ELG was supported in Indonesia. In contrast, there was negative causality from economic growth to export in Indonesia. Ahmad and Harnhirun (1995) conducted time-series method with the variables of real per capita GDP and exports to test ELG hypothesis in a long-run behavioral relationship in five

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Felipe (2003) argued that the essential substance of export and growth is not only about growing by exporting, but by exporting appropriate commodities. The main implication was that ELG strategy was not merely competition in ‗exporting‘ which relied mainly on the developed countries as a market destination. Therefore, a prudent investigation of ELG hypothesis is indispensable in avoiding fallacy composition.

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PRATOMO Mochammad Hadi (MET06080) Association of SouthEast Asian Countries (ASEAN) countries, using annual data from 1966 to 1990. They performed unit roots (ADF test) and cointegration (Johansen-Juselius procedure) test in estimating causality between variables. ECM with constant was created in case there was a cointegration relationship. In the case of Indonesia, the authors found that there was no longrun relationship between exports and economic growth. Rahman and Mustafa (1997) examined the validity of ELG hypothesis in 13 Asian countries, including Indonesia, using annual data from 1965 to 1994. The variables included in the model were real GDP and real export. They tested for stationarity in the series and the order of integration using the ADF test. A cointegration test was conducted using both ADF and Johansen-Juselius procedure; and ECM was performed to combine short-run dynamics and long-run relationship in a unified system. Granger causality test was also conducted for the existence of long-run relationship between variables. The authors concluded that Indonesia experienced unidirectional causality from growth to exports both in short-run and long-run. Ekanayake (1999) analyzed for a causal relationship between GDP and exports in eight developing Asian countries using annual data from 1960 to 1997. He tested for unit roots in the series with ADF test, cointegration between variables (Engle-Granger and Johansen-Juselius procedure) and causality with Granger causality test. Optimal lag was selected with Akaike FPE criterion and ECM was built in accordance with short-run dynamics to obtain long-run equilibrium. The author found that, in Indonesia, bidirectional causality between economic growth and exports occurred in the short-run and the long-run.

3. Methodology 3.1. Theoretical Model One major reason that a country actively participates in international trade is to gain trade. Hopefully, international trade is beneficial and has productive results for a country‘s economic

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PRATOMO Mochammad Hadi (MET06080) development. As expected, trade with other countries has a positive impact for the host country, including the ability to acquire new capital and new technologies. Furthermore, international trade, once carried out, imposes a higher level of production efficiency and tends to allow each country to specialize in producing its particular goods. In the other words, trade between two countries benefits both countries if each country trades or exports the goods in which it has the greatest comparative advantage. The comparative advantage principle led to ELG hypothesis, a new direction for economic policy development. ELG hypothesis postulates that export expansion is a primary determinant of economic growth which, in turn, creates economic development. The association between exports and growth is often attributed to the spillover effect of positive externalities on individual countries which arise from participation in international trade, for instance, is the efficient allocation of labor and capital and economies of scale production (Medina-Smith, 2001). Efficient allocation, as explained in neoclassical trade theory, indicates that international trade occurs due to the comparative advantage which caused by a relative difference in the abundant endowment of various factors in each country (Heckscher-Ohlin theorem). Hence, Heckscher-Ohlin theorem implies that a country produces and exports its commodities based on intensive use of the relatively abundant factors of production or their efficient allocation (Krugman & Obstfeld, 2006). In this theory, economies were assumed to be characterized by constant returns to scale and perfect competition. However, international trade and specialization was also possible resulted from the increasing returns as opposed to this theory. According to the increasing returns theory, because of imperfect competition, trading countries can specialize in the production of different commodities, achieving increased scale-ofproduction while maintaining or increasing the diversity of available resources. Nonetheless,

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PRATOMO Mochammad Hadi (MET06080) the constant return-to-scale model yields the right predictions if the countries are weak in their economies-of-scale and differ greatly, which was the case for most countries (Krugman, 1987). In my study, neoclassical trade theory was evaluated in a neoclassical production function with Cobb-Douglas production function by incorporating exports into the production function. Exports were incorporated into the production function to obtain their correlation with aggregate output. The idea of employing Cobb-Douglas production function was plausible by considering a two-sector growth model and following a set of assumptions: first, the economy was composed of two sectors—one produced single tradable commodities for the world market and the other produced non-tradable commodities for the domestic market; second, both sectors demanded input from the economy, such as capital and labor; third, there were significant productivity differences between the two sectors; fourth, the production of non-tradable commodities depended on the amount of exports. Therefore, this model focused on the likelihood of non-optimum allocation of resources due to a differential of productivity between two sectors and where exports could include a range of positive externalities and spillovers which are not measured by conventional national accounts (Medina-Smith, 2001). The augmented Cobb-Douglas production function which incorporating export is specified as follows: Y = F (K, L, E), (1)

where Y = aggregate output (real GDP), K is capital, L is labor force, and E is aggregate real exports of goods and services. K and L acted as direct input while E was included in the function as a capturer of positive externalities and spillovers. The expected sign in the model was positive for all three variables since they were all expected to have a positive effect on output. The expectation of positive signs came from the principle that the more capital and labor used, the higher the output. The positive sign also expected from the exports variable

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PRATOMO Mochammad Hadi (MET06080) which derived from the premise of ELG hypothesis that the export sector yields positive externalities. 3.2. Econometric Methods Nowadays, economists are more interested in using time-series analysis to study the dynamics between export expansion and economic growth among countries because of the dynamic effect of the series. For example, the results of time-series analysis depend substantially on condition of the analyzed countries, the period chosen, and the econometric method used. Moreover, recent developments in time-series econometrics techniques, especially unit-roots and cointegration techniques, have been altered to model short- and longterm dynamics. In this paper, four common steps of time-series analysis were followed to test for the relationship between exports and economic growth in both the short-run and long-run. The four steps approached in time-series studies were: (1) unit roots test (stationarity test), (2) models specification and the lag order of integration, (3) cointegration and residual diagnostics, and (4) Granger causality test (Gujarati, 2003). This paper followed these steps to ensure that all variables included were stationary—either in levels or in first differences, and models and lag order were properly specified—to observe the likelihood of long-run or short-run relationships among integrated variables and to determine the direction of causalities between exports and growth or vice versa. 3.2.1. Unit Roots Tests Although a conventional model should be estimated using a system estimator or single equation approach, it is important to consider the underlying properties of the processes that generate time-series variables because the presence of unit roots in the series normally behave with stochastic trends. If a series contains a unit root or is non-stationary, then the problem of

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PRATOMO Mochammad Hadi (MET06080) spurious regression may occur, unless it is combined with other non-stationary series‘ to form a cointegrated stationary relationship. Essentially, the unit root test accounts for stationarity of the series. The two most commonly used unit root tests in the literature—the Augmented Dickey-Fuller test (ADF) and the Phillips-Perron (PP)—test were employed in this study. The ADF test was conducted by ―augmenting‖ three equations and adding the lagged values of the dependent variable (ΔYt). The first equation was a pure random walk equation9, the second equation was a random walk with drift or intercept, and the last equation was a random walk with drift around a stochastic trend. The ADF test regression is represented below: ΔYt = β1 + β2t + δYt-1 + αi

  Yt-i + εt
i 1

m

(2)

where ΔYt-1 = (Yt-1 - Yt-2), ΔYt-2 = (Yt-2 - Yt-3), et cetera, and εt is a pure ‗white noise error term‘10. In this equation, the main parameter was δ. If δ was not significantly different from zero or less than critical values, the series definitely contained unit roots or was nonstationary. In this paper, two of the three noted equations were utilized: one with a drift or constant (a0) and another with both a constant and a stochastic trend (a2). The null hypothesis that a0 = δ = 0 was tested for equation with constant. The equation with both constant and trend was tested based on null hypothesis a2 = δ = 0. The test either failed to reject null hypotheses for selected series, then series contains unit roots, or it implied that the series in levels were nonstationary and must be modeled in first differences (I(1)), or were stationary. Otherwise, if

9

Pure random walk is a stochastic trend that in a time-series is changing over time in an unpredictable behavior. ‗White noise error term‘ happens when the value of disturbance term in period t is equal to ρ times its value in previous period plus a purely random error term. In other words, white noise happens if the values in the sequence existed without serial correlation, has mean of zero (E(εt) = 0), and var (εt) = ζ2.
10

16

PRATOMO Mochammad Hadi (MET06080) calculated t-statistics were greater than critical values then the series was stationary and must be modeled in levels (I(0)). Phillips and Perron (1988) generalized and modified DF test procedure. PP test used nonparametric statistical methods for serial correlation in the error term without adding lagged difference terms. On the other hand, the DF test accounted for possible serial correlation in the error term by adding the lagged difference terms of the regressand (Gujarati, 2003). Furthermore, PP test assumed that the expected value of the error term was equal to zero, however PP tests did not require the error term be serially uncorrelated. PP versions of the DF test were flexible in terms of serial correlation between disturbances that can be an autoregressive or moving average form (Patterson, 2000). Both the PP test and ADF test used similar critical values. 3.2.2. Lag Length Selection A critical factor in the specification of appropriate VAR models is the selection of the lag length. There are several criteria recommended for the most appropriate VAR model (Yang, 2002). Some of the criteria are the likelihood ratio test (LR), final prediction error (FPE), the Akaike information criterion (AIC), the Schwarz information criterion (SIC), and the HannanQuin information criterion (HQ). In all alternatives, the model that best fits the data is the one that minimizes the overall sum of squared residuals or maximizes the likelihood ratio. Therefore, this study used AIC since this criteria contributed to the trade off of a reduction in the sum of squared residuals to form a more parsimonious model. Accordingly, two types of bivariate VAR models11 were developed—1) VAR models with only two endogenous variables (GDP and exports); and 2) VARX models with both two endogenous variables (GDP and exports) and two exogenous variables (GFCF and labor).

11

The models called bivariate because of the number of dependent/endogenous variables in the VAR models.

17

PRATOMO Mochammad Hadi (MET06080) The reasoning for developing VAR models without exogenous variables was because of their simplicity. Also, they are commonly used in applied studies related to ELG hypothesis (Rahman & Mustafa, 1997). In this case, the previous studies on the ELG hypothesis applied were based on a pair analysis of causality simply between GDP and exports. The development of bivariate models which incorporate exogenous factors such as capital and labor is based on neoclassical trade theory assumption. This theory has treated capital and labor as inputs of production. Therefore, VAR models with current exogenous variables were introduced into the analysis because the exogenous variables (capital and labor) should be treated as inseparable factors in the production system (related with GDP and exports). The bivariate models incorporating exogenous variables were considered a new dimension of ELG analysis and trade literature because previous studies rarely introduced the exogenous variables into an equation when testing the ELG hypothesis. Previous work that incorporated bivariate models within the equation was done by Sinoha-Lopete (2006). My study followed steps required to develop such a model. In addition, by developing bivariate models with exogenous variables, the comparison with bivariate models without exogenous variables was viable. Bivariate models with exogenous variables were also introduced to reduce problems of possible multi-co-linearity in the data selection. Both bivariate VAR models are written compactly as: yt = β0 + β1 yt-1 + β2 yt-2 + .. + βiyt-p + εt (3)

where yt is a vector containing the variables (GDPt, EXPt, GFCFt, LABt), each of βi represents a coefficient and εt represents the Gaussian white noise error which was assumed to be uncorrelated.

18

PRATOMO Mochammad Hadi (MET06080) 3.2.3. Cointegration and Model Residual Analysis Engle and Granger (1987) developed the cointegration test method to overcome nonstationary time-series due to unit roots inherent problem. They found that a linear combination of two or more non-stationary series may be stationary, so that, if this stationary linear combination exists then the non-stationary time-series are said to be cointegrated. Thus, the stationary linear combination may be interpreted as a long-run equilibrium relationship among the variables. The concept of this long-run relationship was extended by Johansen (1988). He created a procedure based on developing generalized models that allow for a higher order of autoregressive processes, such as in ADF tests. In brief, Johansen‘s procedure is as follows:

For a particular vector autoregressive (VAR) of order of p: yt = A1yt − 1 + … + Apyt−I + Bxt + εt where yt is a k-vector of non-stationary I(1) variables, xt is a d-vector of deterministic variables, and εt is independent and identically distributed n-dimensional vector. Then, this VAR could be rewritten as, Δyt = Πyt-1 + where Π= (4)


i 1

p 1

Γi Δyt−i + Bxt + εt

(5)


i 1

p

Ai – I and Γi = -

j  i 1

p

Aj

(6)

and Π is the long-term matrix containing information whether the condition of yt is either cointegrated or not-cointegrated and Γi is the number of cointegrating relationships (cointegrating rank). This study implements Johansen‘s cointegration procedure to test for the

19

PRATOMO Mochammad Hadi (MET06080) possibility of at least one cointegrating relationship between GDP and exports in all bivariate models developed for Indonesia including the trace and maximum eigenvalue tests. The trace test attempts to determine the number of cointegrating vectors between the variables by testing the null hypothesis that r = 0 against the alternative that r > 0 or r ≤ 1 where r is equal with the number of cointegrating vectors. The maximum eigenvalue tests the null hypothesis that the number of cointegrating vectors is equal to r against the alternative of r + 1 cointegrating vectors. Thus, if the value of the LR was greater than the critical values, the null hypothesis of zero cointegrating vectors was rejected. The econometric model of this relationship captures several bivariate (GDP and exports) models without exogenous variables and with exogenous variables, all expressed in logarithmic form. The econometric model of the relationship between the variables in both types of bivariate models is based on augmented neoclassical trade theory, where all variables are expected to have a positive effect on aggregate output. Therefore, in this analysis, in the bivariate models with exogenous variables, GFCF and labor were treated as exogenous variables. Below is a representation of an econometric model of the bivariate form in this study with exogenous variables: lnYt = β0 + β1 ln EXPt + β2 lnGFCFt + β3 ln LABt + εt , (7)

where Y is aggregate output (real GDP), EXP is total real exports of goods and services, GFCF is real gross fixed capital formation, LAB is labor force, and εt is the stochastic disturbance term (error terms). Econometric theory assumes that the residual sequences in both types of bivariate models are stationary, as the result, the linear combination of non-stationary series will be stationary as well.

20

PRATOMO Mochammad Hadi (MET06080) Model residual analysis was conducted by applying the Ljung-Box residual autocorrelation test and Jarque-Bera normality test 12. The aims of both tests were to ensure that the selected lag lengths were the best fit for the selected VAR models, so that the residuals of the designed models were uncorrelated (white noise) and normally distributed. Ljung-Box test verified that residuals were uncorrelated up to some predetermined number of lags. The latter test examined that the residuals were normally distributed. 3.2.4. Granger-Causality Tests Granger causality has been extensively used in empirical economics related to ELG models as mentioned in subsections 2.2.2 and 2.2.3. This study tested for the direction of causalities between GDP and exports in the final stage of analysis as well. Specifically, it tested covering bivariate models without exogenous variables and bivariate models with exogenous variables. To test for causality between GDP and exports, three Granger causality alternative models were stipulated on both types of bivariate models: VAR in levels, VAR in first differences, and the error correction model (ECM). The VAR in Level model assumes the series are to be integrated of order zero (stationary)—I(0) in levels. When the unit roots test indicates that series in levels are stationary, they can be modeled as VAR-L. If the series of this study are stationary in levels, various VARL are developed for both types of bivariate models. These models were used to test for Granger-causality between GDP and exports. The models tested for VAR-L with exogenous variables are specified as follows: lnYt = b10 +  ϕ1i lnYt-i +  b1j lnEXPt-j +  λ1k 1nGFCFt-k +  ρ1l lnLABt-l + εt1
i 1
j 1

p

p

p

p

(8)

k 1

l 1

12

If the model defects at the checking stage, for example, if residual autocorrelation was found, this is an indication of representation of poor models in data generation process. Improvements are then made by adding other variables or lags to the model by including nonlinear terms or changing the functional form (Lutkepohl, 2004).

21

PRATOMO Mochammad Hadi (MET06080) ln EXPt = b20 +  b2i lnEXPt-i +  ϕ2j lnYt-j +  λ2k lnGFCFn +  ρ2m lnLABt-l +εt2, (9)
i 1
j 1

p

p

p

p

k 1

l 1

where φ, b, λ, and ρ represent the coefficients of the variables; and εt1 and εt2 are random disturbances with mean zero, without serial correlation and stationary. The lag length orders of the variables are p as an autoregressive process and b as exogenous variables. The null hypotheses (H0) state that, exports do not Granger-cause economic growth and economic growth does not Granger-cause growth in export. Based on equations (8) and (9), the joint hypotheses for Granger non-causality between GDP and exports, is specified as follows:

From EXP → GDP (for equation 8), If H0: b11 = b12 =… b1p = 0, From GDP → EXP (for equation 9), If H0: φ21 = φ 22 =… φ2p = 0.

The VAR model in first differences (VAR-FD) was used if results of unit root test indicated that the variables were integrated of order one—I(1) but not cointegrated. When this was the case, Granger-causality was tested to estimate VAR-FD for both types of bivariate models. Below is the representation of GDP and exports in VAR-FD model with exogenous variables:

ΔlnYt =b10+


i 1

p

ϕ1iΔlnYt-i+  b1jΔlnEXPt- j+  λ1kΔ1nGFCFt-k +  ρ1lΔlnLABt-l + εt1 (10)
j 1

p

p

p

k 1

l 1

Δln EXPt =b20+


i 1

p

b2iΔlnEXPt-i+


j 1

p

ϕ2jΔlnYt-j+


k 1

p

λ2kΔlnGFCFn+


l 1

p

ρ2mΔlnLABt-l+εt2 , (11)

where Δ is the first difference operator.

22

PRATOMO Mochammad Hadi (MET06080) The null hypotheses (H0) state that, exports do not Granger-cause economic growth and economic growth does not Granger-cause growth in export. Based on equations (10) and (11), the joint hypothesis for Granger non-causality between GDP and exports based on no cointegrating relationships is specified as follows:

From EXP →GDP (for equation 10), If H0: b11 = b12 =… b1p = 0, From GDP → EXP (for equation 11), If H0: φ21 = φ 22 =… φ2p = 0.

The error correction model (ECM) applies to nonstationary series that are known to be cointegrated. When this is the case, ECM should be applied because it has cointegration relations built into the specification so that it restricts the long-run behavior of the endogenous variables. The ECM is used to estimate the significance of the error term in the cointegrating vectors to see if long-run equilibrium will gradually achieve and contemporaneous changes in the variables that determine equilibrium are adjusted (Patterson, 2000). In sum, ECM has both long-run and short-run properties built in. The long-run properties are embedded in error term while the latter is partially captured by the equilibrium error term (Koop, 2000). If the series in this study were nonstationary and cointegrated, then cointegrating equations was extended by incorporating the error term into the models and testing for the significance of the adjustment coefficients in each of the cointegrating equations. Below is an illustration of GDP and exports equations that fit the ECMs in the bivariate model without exogenous variables (equation 12 and 13) and the bivariate model with exogenous variables (equation 14 and 15):

23

PRATOMO Mochammad Hadi (MET06080)

ΔlnYt = b10 +


i 1

p

ϕ1iΔlnYt-I +  b1jΔlnEXPt- j - χZt-1 + εt1 ,
j 1

p

(12)

Δln EXPt = b20 +


i 1

p

b2i ΔlnEXPt-I +  ϕ2jΔlnYt-j - χZt-1 + εt1 ,
j 1 p
p p

p

(13)

ΔlnYt=b10+


i 1

p

ϕ1iΔlnYt-i+  b1jΔlnEXPt- j+  λ1kΔ1nGFCFt-k+  ρ1lΔlnLABt-l -χZt-1+εt1, (14)
j 1
k 1 l 1

ΔlnEXPt=b20+


i 1

p

b2iΔlnEXPt-i+


j 1

p

ϕ2jΔlnYt-j+

λ
k 1

p

2kΔlnGFCFn+

ρ
l 1

p

2mΔ lnLABt-l

-ζZt-1+εt2, (15)

where χ and ζ are long-run adjustment parameters and Zt-1 is the error correction term representing lagged residuals from cointegrating relationship. From the previous four equations (12, 13, 14 and 15), the joint hypotheses for Granger non-causality based on first difference I(1) and cointegrated equations for both types of bivariate models is specified as follows:

There is no Short-Run Causality: The null hypotheses state that, in the short-run, exports do not Granger-cause GDP and GDP does not Granger-cause exports.

From EXP → GDP, If H0: b11 = b12 =… b1p = 0, From GDP → EXP, If H0: φ21 = φ 22 = … φ2p = 0.

There is no Long-Run Causality: The null hypotheses state that, in the long-run, exports do not Granger-cause GDP and GDP does not Granger-cause exports.

24

PRATOMO Mochammad Hadi (MET06080) From EXP → GDP, If H0: χ = 0, From GDP → EXP, If H0: δ = 0.

There is no Total Causality: The overall null hypotheses state that, exports do not Grangercause GDP and GDP does not Granger-cause export.

From EXP → GDP, If H0: b11 = b12 =… b1p = χ = 0, From GDP → EXP, If H0: φ21 = φ 22 =… φ2p = δ = 0. In all error correction models, failure to reject the null hypotheses indicates that the exports led growth (ELG) and GLE hypothesis are not valid. 3.3. Disaggregate Analysis The econometrics methods provide a basis of empirical evidence to produce an analysis based on the obtained results. Yet, the necessity in bridging with practical implementation is important. Therefore, in section 4.3, the result of the econometrics methods in accordance with ELG hypothesis testing is analyzed further with the Indonesia‘s actual exports performance in various years based on the data obtained from World Trade Organization (WTO) and International Trade Center (ITC). The disaggregate analysis of empirical evidence and real performance of exports is plausibly significant to obtain unambiguous picture of exports‘ condition in Indonesia.

25

PRATOMO Mochammad Hadi (MET06080) 4. Results and Discussion This section presents the results of the ELG hypothesis investigation of Indonesia for the period 1980–2004. It consists of three sub-sections: Sub-section 4.1 describes economic performance related to the examined variables of the analyzed periods; Sub-section 4.2 portrays the results of the econometrics analysis (unit roots, cointegration and Granger causality test) used to test connecting linkages between economic growth and exports; and, sub-section 4.3 discusses a comparative analysis of the ELG hypothesis and the findings in accordance with macroeconomic perspective. 4.1. Descriptive Statistics Analysis Four macroeconomic indicators (real GDP, real exports, real GFCF, and labor force) were analyzed in this study to describe Indonesia‘s economic performance. As shown in Figure 1 (Appendix B), since 1980, all four macroeconomic indicators trended upward. However, the impact of Asian financial crisis in 1997 resulted in a declining trend for GDP, exports, and GFCF during certain periods. GDP increased rapidly from 1980 until 1997. The average 7% per year economic growth rate caused significant changes in GDP value. However, in 1998, the crisis contracted GDP by 13.6%. Subsequently, economic growth started to rise again in 1999, although the rate of economic growth was not as spectacular as before the crisis. In Indonesia in the early 1980s, the export rate was not stable due to the oil price drop at the time. The value of exports, which relied mainly on oil exports, was also affected. Signs of change began to appear in 1985 after the government reformed several policies including the fiscal, monetary, and trade procedures that diversified exports so that they were not so highly dependent on oil. The years between 1980 and 1985 were transitional for the exports sector, which moved from oil reliance to more diversified commodities. Unfortunately, the disastrous

26

PRATOMO Mochammad Hadi (MET06080) 1997 financial crisis had a huge impact on exports. In 1999, the value of exports plunged more than 31% compared with the previous year. The unstable macroeconomic condition and significant losses of exports value were suspected as major causes in the decline of exports. However, beginning in 1999, the exports sector started to rise again with average growth of 8% per year. GFCF had a strong relationship with foreign direct investment (FDI). Since the government reformed investments regulations in the mid-1980s and gradually improved the investment climate, FDI, as reflected in GFCF, showed acceleration in investment value from USD 13.8 billion in 1984 to USD 51.2 billion in 1997. In other words, there was an average growth rate of 9.8% per year from 1984 to 1997. However, the financial crisis hurt the investment sector with a 45.2% fall in 1999 before the sector started to regain steadily in 2000. The labor force in Indonesia increased at a steady rate. On average, the labor force growth rate was 2.6% per year from 1980 to 2004. The relationships among GDP, exports, GFCF, and labor force are discussed in the following paragraph in terms of correlation analysis. A correlation matrix analysis (Table 2, Appendix A) was performed to investigate the correlation between variables (real GDP, real exports, real GFCF, and labor force). The results showed significant and positive correlation among variables (on average, more than 90% of each variable). However, strong correlation does not imply causation from one variable to another (e.g., causation from exports to GDP or vice versa). Therefore in the following section, this study examined the three methods commonly used in time-series analysis in accordance with validity of ELG hypothesis. Econometrics techniques such as stationarity test, cointegration test, and Granger causality test was employed to find short-run relationship, long-run relationship, and direction of causation between exports and economic growth.

27

PRATOMO Mochammad Hadi (MET06080) 4.2. Econometric Analysis 4.2.1. Unit Root Tests Unit root tests were conducted first, with real GDP, exports of goods and services, GFCF, and labor as the time-series variables considered in this study. These variables must be stationary or cointegrated in order to avoid a spurious regression situation and to ensure whether they are stationary or not. ADF and PP test were conducted with critical values 10% applied for both test. The results of both tests are summarized in Table 1 (Appendix A). This table is the result of the unit root test for Indonesia‘s annual data (1980–2004) on all four series (GDP, exports, GFCF, and labor). The distribution of the table is as follows: Column 1 represents the equations used with a constant and both constant and a trend (ADF and PP test); Column 2 captures the series in logarithmic form and the optimum lags in level for ADF test; Column 3 shows the null hypothesis in levels and in first difference for ADF and PP test; Columns 4 through 7 summarize the t-statistics and decision to accept or reject the null hypothesis in levels condition. The second part of Table 1 (columns 8 through 12) summarizes the ADF and PP tests in first differences and the decision of accepting or rejecting the null-hypothesis. Both in levels and in first differences, the optimum lags were acquired using AIC. For Indonesia, the ADF and PP test results indicated that all of the series are nonstationary in levels or the results failed to reject the null-hypothesis except for variable exports with constant trend in lag 0. This finding of nonstationary series is consistent with previous literature that demonstrated for most of macroeconomics series is expected to contain unit root. Thus, to correct for the presence of unit root in all series, first differences measures were taken. The result of the unit roots tests in first difference based on ADF tests and PP tests showed that, for the most part, GDP, exports, GFCF, and labor were stationary in their first

28

PRATOMO Mochammad Hadi (MET06080) difference. Therefore, all variables were found to be integrated in order 1 in the models with trend or without trend. 4.2.2. Lag Length Selection There are several statistical criteria which might be used to determine the optimal number of lags for a VAR in levels. There are the AIC, the Schwartz-Bayesian Criterion (SBC), and the LR test. This study employed AIC due to the limited sample size range used to estimate the appropriate number of lags entering the VAR of two types of bivariate models (VAR (p) and VARX (b) model). The result of lag length selection showed that the optimum number of lags in the specified VAR (p) model was 3 when the AIC is minimum (-6.683711). For VARX (b), the AIC showed that VARX model was optimum at 1 when AIC is minimum (-7.114560). Hence, the AIC identified the optimum number of lags on a VAR model of order 3 and 1 for VAR (p) and VARX (b) respectively. These models were used to test for cointegration between economic growth (real GDP) and real exports in Indonesia. 4.2.3. Cointegration and Model Residual Analysis Having confirmed unit roots presence in all data series and the findings of stationarity in first difference, the next step was a two-step Engle-Granger cointegration procedure. The first procedure was to determine the order of integration and long-run equilibrium relationship (if the series are stationary in first difference then the long-run relationship among variables needs to be estimated13). The second procedure was to specify ECM to account for short-run equilibrium if the variables are cointegrated or stationer in first difference- I(1).

13

Engle-Granger suggests regressing each variable against all other variable in order to estimate long-run equilibrium.

29

PRATOMO Mochammad Hadi (MET06080) Johansen‘s cointegration test was employed for both VAR (p) and VARX (b) model to find long-run equilibrium between variables. In other words, to determine if the variable were related to each other in the long-run. The assumption behind the cointegration test that performed in this study was that there is a deterministic trend in that the data allows for appropriate ECM estimation in a cointegrating equation. Trace and maximum eigenvalue tests were applied to determine the rank of cointegration. For the trace test, the critical value at 5% was 15.49471 at r = 0 and 3.841466 at r =1. For maximum eigenvalue test, the critical value at 5% was 14.26460 at r = 0 and 3.841466 at r = 1. If both tests‘ results indicated larger value than critical value then null hypothesis was rejected, and failed to reject null hypothesis if otherwise. Table 3 (Appendix A) demonstrated the summary of Johansen‘s cointegration test, for both the cointegration test on the bivariate model without exogenous variable and cointegration test on the bivariate model with exogenous variables. Column 1 represents the bivariate model that was used. Column 2 corresponds to the null hypothesis of both trace and maximum eigenvalue test. Column 3 and 4 indicate the computed values of trace and maximum eigenvalue. The last column represents the rank of cointegration. Overall, there was one cointegrating relationship between real GDP and real exports for the bivariate model without exogenous variable. And there were two cointegrating relationships between real GDP and real exports for the bivariate model with exogenous variables. Based on this test, economic growth and its selected determinants exhibited a long-run relationship. This means that real GDP, exports, GFCF, and labor tend to move jointly over the entire period of analysis. Residual analysis of the models was conducted for adequacy of selected models with respect to autocorrelation and normality. The tests used were the Ljung-Box test for autocorrelation and the Jarque-Bera test for normality. The null hypothesis for autocorrelation

30

PRATOMO Mochammad Hadi (MET06080) test showed that there was no autocorrelation up to the lag specified and the null hypothesis for normality test was based on the assumption that the residual were normally distributed. The rejection of the normality test might indicate heterocedasticity in the model. The results for both models (bivariate model without exogenous variable and bivariate model with exogenous variables) are presented in Table 4 (Appendix A). The autocorrelation test results indicated that there was no presence of autocorrelation for either model except for lag four in the bivariate model without exogenous variable. Normality test results showed that for the bivariate model without exogenous variable, the residuals were not normally distributed. On the other hand, the normality test results did indicate for residuals normal distribution in the bivariate model with exogenous variables. 4.2.4. Granger-Causality Tests The cointegration test results showed that two of three alternative VAR models proposed were applicable in this study14. There were VAR-L (causality with full rank variable) and ECM (causality with cointegrated series). Therefore, the Pairwise Granger causality test was performed in search of a direction of causation between real GDP and exports. Similar lag length in the specified VAR (p) and VARX (b) models were used to estimate VAR-L and ECM. Tables 5 and 6 (Appendix A) demonstrate the summary of the Pairwise Granger Causality test of ELG and GLE for both types of bivariate models. The decision to reject the null hypothesis of no causality between variables was transformed into a conclusion of YES in the last column of the table and a conclusion of NO otherwise. Table 5 shows that at 5% critical value, the results of the causality test showed that exports do not cause real GDP, implying the

14

There are three proposed models in the methodology section prepared to anticipate the results of cointegration test. As mentioned in section 3.2.4., VAR in levels (VAR-L), VAR in first difference (VAR-FD), and ECM models are the three proposed models.

31

PRATOMO Mochammad Hadi (MET06080) acceptance of ELG hypothesis was not valid. However, the causality test results did indicate that there was strong causation from GDP to exports. In general, with full rank bivariate models with exogenous variables, unidirectional causality was found from GDP to exports. Therefore, it was concluded that for this model, only GLE was valid for Indonesia. According to the results of the cointegration test, the ECM was applicable for the bivariate model without exogenous variables. A vector ECM is a restricted VAR designed for cointegrated nonstationary series in levels. The ECM has a cointegration relationship built in so that it restricts long-run behavior of endogenous variables to converge on their cointegrating relationship in accordance with short-run adjustment dynamics. The term ‗cointegration‘ also known as the error correction term since the deviation from long-run relationship is adjusted gradually via a series of partial short-run adjustments. Therefore, the significance of error correction term was tested to determine the convergence speed of GDP and exports in bivariate model without exogenous variable. The ECM test results (Table 6, Appendix A) indicated: Firstly, for the model with exogenous variable no causation was found from exports to GDP, but, on the contrary, there was strong causation from GDP to exports. Secondly, the evidence for the model without exogenous variables indicated that both in the short-run and the long run that there were no causations found from exports to GDP. In other words, for both short-run and long-run, there was no evidence found to support the ELG hypothesis in Indonesia. In contrast, there was strong causation in short-run and long-run from GDP to exports. Hence, at a 5% critical value, there was a unidirectional causality that existed from GDP to exports in Indonesia. 4.3. Disaggregate Analysis ELG hypothesis was investigated in Indonesia from 1980 to 2004. Two types of bivariate models (VAR and VARX) were estimated and the direction of causation between growth and export were examined both in the short-run and the long-run as well. The results of causality 32

PRATOMO Mochammad Hadi (MET06080) indicate that growth rate has contributed to the exports sector. This finding implied that economic growth in Indonesia was driven mostly by factors other than exports. Furthermore, this finding was corroborated by Rahman and Mustafa‘s (1997) conclusion that Indonesia experienced unidirectional causality from growth to exports both in the short-run and the longrun. The findings of GLE have broad spectrum implications. Firstly, the rate of export growth relies on the economic growth rate. Hence, government should place more emphasis on developing higher economic growth rate policies to spur exports. Secondly, the use of exports as major determinants of economic growth as stated in ELG hypothesis might encounter problems in practice. Perhaps, the problems may be attributed to the inadequate competitiveness, inaccurate strategies, and ineffective execution of export policies The competitiveness of the exports commodities sector should be questioned. Indonesia‘s trade performance index in 2003 (Table 9, Appendix A) showed that for 12 export sectors, there were merely two sectors (wood products and clothing) which achieved a top ten position in the world market. Moreover, for both sectors, their share in the world export market was merely less than 3% implied that the exporter of wood products and clothing was not being dominant player in world market. In addition, other export sectors (electronic component, IT and consumer electronics, miscellaneous manufacturing, chemicals, basic manufactures, transport equipment, and non-electronic machinery) also had inadequate performances which reflected their share less than 1% share in the world market. Another issue related to export competitiveness was comparative advantage. As mentioned in section 3.1, comparative advantage is obtained by intensive use or efficient allocation of relatively abundant endowment factors. Table 11 (Appendix A) represents a specialization index describing the degree of comparative advantage of Indonesia‘s group of commodities for 2003. From the table description, only wood products successfully attained more than a three

33

PRATOMO Mochammad Hadi (MET06080) point level for comparative advantage. By contrast, several commodities (IT and consumer electronics, electronics components, miscellaneous manufacturing, chemicals, non-electronics machinery, basic manufactures, and transport equipment) were miserably stuck below one point level. The indicator of comparative advantage in Table 10 inferred that efficient allocation was underachieved despite Indonesia‘s relative abundance of endowment factors. In the wider perspective of competitiveness, Indonesia‘s exports performance was related to the achievement of exports. Table 12 (Appendix A) ranks exports performance based on various categories. In general, in terms of ranking in net exports, in the manufacturing exports categories, there were four sectors (basic manufacturing, chemicals, non-electronic machinery and transport equipment) under performed in records. Especially for the basic manufacturing sector, there was a sharp decline in achievement from ranking 33 in 2001 to ranking 102 in 2005. In case of product diversification, there were only two sectors (clothing and IT and consumer electronics) that achieved a top ten position. However, despite this product diversification in the clothing sector, it still lagged behind in terms of an adaptation effect and matching with dynamic world demand. It means that for the clothing sector, the effort of product diversification was not paired with adaptation to rapidly changing world demand. Deeper concern for the value of export commodities must be seriously considered. As shown in the category of relative unit value (Table 12, Appendix A), all export products from Indonesia had relatively low values. Meaning, the export products had low added value contents built into the commodities. Secondly, it means that there was no significant improvement in product quality. The issue of export competitiveness has become more important in recent years. The world globalization trend is signed with the increased popularity of free trade areas around the

34

PRATOMO Mochammad Hadi (MET06080) world15. Regionally, free trade area establishment in Southeast Asia dates back to 199216. In the broader region, the Asia-Pacific Economic Cooperation (APEC) organization was established in 198917. Despite its purpose of further enhancing economic growth and prosperity for its members, the establishment of these organizations has consequences in higher competitiveness demands for commodities of export. One issue regarding the ineffective export policy is market destination. Indonesia‘s conventional export market destinations were United States and Japan. As shown in Table 10 (Appendix A), although the proportion of export share in both countries declined from 67.9% in 1985 to 36.9% in 2001, they accounted for more than one third of aggregate exports. High dependence on conventional markets posed a potential hindrance to market expansion. The findings in Table 12 (Appendix A) also support high dependence on the conventional market. In case of market diversification ranking, most of the exports sectors were concentrated on the existed market resulting in low ranking level for market diversification. With the rise of new emerging markets (i.e., China, Russia, South Asia, Latin America, and Western-Southern Africa), there are possibilities to explore this new prospective market 18. Inaccuracy of exports strategic development was underpinned by shortcomings in predicting the world exports pattern. As shown in Table 7 (Appendix A), from the 1980s, the growth rate of agricultural products and mining in the world had relatively a small increase compared with manufactured products. Unfortunately, from 1988 to 2005 the exports composition from Indonesia relied heavily on mining products which on average accounted for 31% share of total exports (Figure 2, Appendix B). The major disadvantage of focusing on
15

Free Trade Area is an agreement at a bilateral or multilateral level, in which each country‘s commodities can be shipped to the other(s) without tariffs; however this country may set tariffs against the rest of the world (Krugman and Obstfeld, 2006). 16 One purpose of ASEAN-Free Trade Area (AFTA) establishment is to eliminate tariff barriers among ASEAN members with the goal of regional economic integration. 17 Similarly with AFTA, APEC works to reduce tariffs and other trade barriers across the Asia-Pacific region. 18 As pointed out by the Goldman Sachs investment bank, they argued that the economies of ‗BRICs‘ (Brazil, Russia, India, and China) are rapidly developing and by the year 2050 they will surpass most of the current richest countries. On almost every scale, these countries will be the largest entity on the global stage by 2050.

35

PRATOMO Mochammad Hadi (MET06080) mineral products referred to non-renewable resource characteristics which mean that at some point they will be depleted. However, according to Table 2 (Appendix A), positive and significant correlation between GDP and exports was found in Indonesia. This finding indicated positive spillover externalities between exports and growth. Although there lacked current export strategies, the crucial role of exports in economic growth is indubitable.

5. Conclusions and Policy Implications This paper reinvestigated the ELG hypothesis for Indonesia using annual data for the period 1980–2004. Time-series techniques such as unit root tests (ADF and PP tests), cointegration test (Johansen‘s procedure), and Granger causality tests were applied to test the causal relationship between exports and economic growth. This paper contributes to the existing literature on ELG hypothesis—especially on studies of ELG hypothesis for Indonesia—by implementing comparative analysis with duo models (model with exogenous variables and without exogenous variables) which had been used rarely in empirical ELG hypothesis studies. In addition, disaggregate analysis with actual export performance as a counterpart of econometric analysis was regarded as strengthening measures of econometrics results. Below is the summary of major findings of econometrics analysis and disaggregate analysis. The unit roots test result from ADF and PP tests indicated that all of the series is nonstationary in levels and subsequent tests in first difference showed that most of the variables were stationary. Johansen‘s cointegration test demonstrated that for both models, long-run relationships existed between GDP and exports. There were cointegrating relationships for the model without exogenous variable and for the model with exogenous variables. The Granger causality test indicated that direction of causation in the long-run occurred from GDP to exports

36

PRATOMO Mochammad Hadi (MET06080) for the model with exogenous variables. Parallel results were also obtained from the model without exogenous variable that direction of causation existed from GDP to exports both in the short-run and long-run. Therefore, based on these results, there was no evidence to support the ELG hypothesis in Indonesia. In contrast, there was GLE that existed as reflected in the unidirectional causality from growth to exports. This finding was corroborated by the conclusions of previous studies (Rahman & Mustafa, 1997) that Indonesia experienced unidirectional causality from growth to exports both in the short-run and long-run. The result of the econometrics test implied that export growth was driven mainly by economic growth. Hence, policy should place more emphasis on higher economic growth to spur exports. Secondly, the idea of exports as major determinants of economic growth might have problems in running exports policies. As discussed in sub-section 4.3, there are at least three major problems related to the exports situation in Indonesia. These problems are: inadequate competitiveness, inaccurate strategy, and ineffective execution of export policies. Therefore, three important policy implications can be drawn from this analysis to deal with unsatisfactory exports performance. First, in order to improve Indonesia‘s exports competitiveness, the government should lift the barriers that restrict the creation of a conducive business climate. Consequently, deregulation and elimination of ‗the high cost economy‘ is highly recommended. Furthermore, the availability of adequate infrastructure is undoubtedly needed to support the efficient distribution and effective production of export commodities. Secondly, prioritizing high value added manufactured exports commodities seems to be an effective way to boost exports performance since the world demand for manufactured products is higher than agricultural and mineral products. In addition, by making high value added manufactured commodities a priority, there are larger multiplier effects on the macroeconomic environment. Furthermore, it will strengthen the competitiveness levels of aggregate exports by

37

PRATOMO Mochammad Hadi (MET06080) reducing the dependence on primary export products because the price of primary products tends to be highly fluctuating. Therefore, government should address this priority by providing special incentives for some targeted high value added manufactured industries. The incentives may be in the form of tax holidays (especially for initial establishment), full support for research and development, and tariff reduction (on some specific imported raw and intermediate materials and machinery). Lastly, full efforts should be made to increase market diversification with the goal of reducing dependency on conventional markets and anticipating the rise of new emerging markets. The strategies could be implemented in trade negotiation and promotion as parts of expansion toward targeted markets. Government should actively participate in trade negotiations at bilateral and multilateral levels with the goal of minimizing trade barriers to destination markets, including establishing free trade area agreements. Moreover, facilitating export commodity exhibitions and promoting prospective buyers to trade are necessary to acquire more access to potential markets.

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PRATOMO Mochammad Hadi (MET06080)

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PRATOMO Mochammad Hadi (MET06080) ITC. Trade performance index. Retrieved April 20, 2007, from http://www.intracen.org/menus/countries.htm Johansen, S. (1988). Statistical analysis of cointegration vectors. Journal of Economics Dynamics and Control, 12, 231–254. Koop, G. (2000). Analysis of economic data. Chichester: John Wiley & Sons, Ltd. Krugman, P. R. (1987). Is free trade passé? Economic Perspectives, 1(2), 131–144. Krugman, P.R. and Obstfeld, M. (2006). International economics theory & policy. Boston: Pearson-Addison Wesley. Lütkepohl, H. & Krätzig, M. (2004). Applied time series econometrics. Cambridge: Cambridge University Press. Mah, J.S. (2005). Export expansion, economic growth and causality in China. Applied Economic Letters. 12, 105–107. Mamun, K.A., & Nath, H.K. (2005). Export-led growth in Bangladesh: a time series analysis. Applied Economic Letters. 12, 361–364. Matsumoto, Y. (2007). Financial fragility and instability in Indonesia. New York: Routledge Contemporary Southeast Asia Studies. Medina-Smith, E. J. (2001). Is the export-led growth hypothesis valid for developing countries? A case study of Costa Rica. (Policy Issues in International Trade and Commodities Study Series No. 7). University of Sussex, United Kingdom and Universidad de Carabobo, Venezuela, United Nations, New York and Geneva. Patterson, K.D., (2000). An introduction to applied econometrics: a time series approach. (MacMillan, London). Paul, S. & Chowdhury, K. (1995). Export-led growth hypothesis: some empirical testing. Applied Economic Letters. 2, 177–179. Phillips, P.C.B. & Perron, P. (1988). Testing for a unit root in time series regression. Biometrika. 75, 335–346. Prawiro, R. (2001). Indonesia’s struggle for economic development: pragmatism in action. New York: Oxford University Press. Rahman, M. and Mustafa, M. (1997). Dynamics of real exports and real economic growth in 13 selected Asian countries. Journal of Economic Development, 22(2), 81–95. Ram, R. (1987). Exports and economic growth in developing countries: evidence from time series and cross-section data. Economic Development and Cultural Change, 36, 51–72. Richards, D.G. (2001). Exports as a determinant of long-run growth in Paraguay, 1966–96. The Journal of Development Studies. 38(1), 128–146. Shan, J. & Sun, F. (1998). On the export-led growth hypothesis for the little dragons: an empirical investigation. Atlantic Economic Journal. 26(4), 353–371. Shan, J & Tian G.G. (1998). Causality between exports and economic growth: the empirical evidence from Shanghai. Australian Economic Paper. 37(2), 195–202. Shirazi, N. S. & Abdulmanap, T.A. (2005). Export-led growth hypothesis: further econometric evidence from South Asia. The Developing Economies. 63(4), 472–488. Sinoha-Lopete, R. (2006). Export-led growth in Southern Africa. Unpublished master‘s thesis, Louisiana State University. Retrieved March, 25, 2007 from http://etd.lsu.edu/docs/available/etd-04072006-114156/ Todaro, M.P. & Smith, S.C. (2006). Economic Development. London: Pearson-Addison Weasley. Woo, W.T., Glassburner, B., & Nasution, A. (1994). Macroeconomic policies, crises, and longterm growth in Indonesia, 1965–90. Washington: World Bank. World Trade Organization. (1998). Trade policy review: Indonesia. Geneva: WTO. WTO. (n.d). Project LINK world economic monitors. Retrieved April 20, 2007 from http://www.chass.utoronto.ca/link/200010/WTOtrade1.pdf

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PRATOMO Mochammad Hadi (MET06080) WTO. (June 30, 2003). Trade policy review: Indonesia. Retrieved April 21, 2007, from http://www.wto.org/english/tratop_e/tpr_e/tp216_e.htm World Bank. (1993). The East Asian miracle: economic growth and public policy. Oxford: Oxford University Press. World Bank. (2006). World development indicators 2006. [CD-ROM]. World Bank. Yang, M. (2002). Lag length and mean break in stationary VAR models. The Econometrics Journal. 5, 374–386.

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Appendix A: Tables Table 1. Augmented Dickey-Fuller and Phillips-Perron Unit Root Tests on GDP, Exports, GFCF, and Labor for Indonesia (1980–2004)
Unit Root Test in Levels ADF PP Equation (1) Constant No Trend Constant Trend Constant No Trend Constant Trend Constant No Trend Constant Trend Series/Opt. Lag Null Hypothesis (ADF) (Unit Root) (2) (3) Lg GDP 0 1 Lg EXP 1 0 Lg GFCF 2 1 γ =0 γ = a2 = 0 -1.11714 -2.16213 I(1) I(1) -1.29919 -1.4235 I(1) I(1) 1 1 -3.73740 -3.69915 I(1) I(1) -3.11546 -2.94906 I(2) I(2) γ =0 γ = a2 = 0 -0.34479 -3.25208 I(1) I(0) -0.12513 -3.26828 I(1) I(0) 0 0 -6.02635 -5.86882 I(1) I(1) -6.2815 -6.0678 I(1) I(1) γ =0 γ = a2 = 0 T-Stat (4) -1.49347 -1.32772 Decision I(d) (5) I(1) I(1) T-Stat (6) -1.49347 -1.12026 Decision Series/Opt. I(d) Lag (ADF) (7) (8) I(1) I(1) 0 0 Unit Root Tests in First Difference ADF PP T-Stat (9) -3.54087 -3.59527 Decision I(d) (10) I(1) I(1) T-Stat (11) -3.56325 -3.61675 Decision I(d) (12) I(1) I(1)

Lg Lab Constant No 0 γ =0 -0.96615 I(1) -0.95765 I(1) 0 -4.31058 I(1) -4.31121 I(1) Trend Constant 2 γ = a2 = 0 -2.0285 I(1) -1.79742 I(1) 0 -4.38845 I(1) -4.37700 I(1) Trend Note: ADF and PP test: Null hypotheses (levels and in first diff) at 10% level of significance: constant and no trend (γ = 0); constant and no trend (-2.63); constant and a trend for γ = a2 = 0 (-3.24).

42

PRATOMO Mochammad Hadi (MET06080) Table 2. Correlation Matrix Analysis for Real GDP, Real Exports, Real GFCF and Labor in Indonesia for period 1980–2004 Series Lg_GDP Lg_EXP Lg_GFCF Lg_LAB Lg_GDP 1 0.957268 0.969382 0.975149 Lg_EXP 0.957268 1 0.932712 0.936205 Lg_GFCF 0.969382 0.932712 1 0.901210 Lg_LAB 0.975149 0.936205 0.901210 1

Note : - Series are stated in log term

Table 3. Cointegration Test on Bivariate Models for Indonesia (1980–2004) Bivariate Models Without exogenous variable With exogenous variables H0: r (Rank) 0 1 0 1 Trace (λtrace) 33.29147 3.081437 51.55661 17.14656 Max Eigenvalue (λtmax) 30.21004 3.081437 34.41005 17.14656 RANK 1

2

Note: critical value at 5% for trace test is 15.49 at r = 0 and 3.84 at r = 1, critical value for max. eigenvalue test at 5% is 14.26 for r = 0 and 3.84 at r = 1.

Table 4. Results for the Residual Analysis for Indonesia (1980–2004) A. Bivariate Model Without Exogenous Variable Autocorrelation Normality Up to lags Q-stats p-value Component Jarque-Bera df p-value 4 9.623084 0.0473 1 21.89594 2 0.0000 5 15.03114 0.0585 2 2.331583 2 0.3117 6 17.19013 0.1426 Joint 24.22753 4 0.0001 H0: No autocorrelation up to lag H0: Normally distributed residuals. (at 5% critical specified. (at 5% critical value) value) B. Bivariate Model With Exogenous Variables Autocorrelation Normality Up to lags Q-stats p-value Component Jarque-Bera df p-value 2 7.136716 0.1288 1 0.868330 2 0.6478 3 10.44619 0.2351 2 1.155400 2 0.5612 4 13.11070 0.3610 Joint 2.023731 4 0.7314 H0: No autocorrelation up to lag H0: Normally distributed residuals. (at 5% critical specified. (at 5% critical value) value)

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PRATOMO Mochammad Hadi (MET06080)

Table 5. Pairwise Granger Causality Test on Bivariate Full Rank Models with Exogenous Variables for Indonesia (1980–2004) Direction Lags F-Statistic p-value Exports  GDP 1 0.93781 0.34386 GDP  Exports 1 50.9781 0.00000 H0: No Granger causality between variables (at 5% critical value) Conclusion NO YES

Table 6. Pairwise Granger Causality Test on Bivariate Models without Exogenous Variables for Indonesia (1980–2004) Direction Lags F-Statistic p-value Exports  GDP Short-run 3 0.05396 0.98280 Long-run 3 0.04753 0.98572 GDP  Exports Short-run 3 13.8202 0.00018 Long-run 3 25.3959 0.00001 H0: No Granger causality between variables (at 5% critical value) Conclusion NO NO YES YES

Table 7. Long-term Development of World Exports Periods 1950–1960 Average 1960–1970 Average 1970–1980 Average 1980–1990 Average 1990–2000 Average 2000–2005 Average
Note: Agr. Mng. Mnf.

A. Values (Growth Rate, %) Total Agr. Mng Mnf. 7.7 3.6 8.8 10.7 9.3 4.9 9.3 11.5 20.4 16.6 27.2 19.1 5.5 3.4 -1.4 8.3 6.2 2.8 5.6 6.9 10.1 9.0 9.0 9.2

B. Volumes (Growth Rate, %) Total Agr Mng Mnf. 7.7 4.9 8.1 8.7 8.6 3.9 7.2 10.5 5.3 3.5 1.7 7.1 3.9 1.5 1.0 5.6 6.4 3.9 4.0 7.1 4.7 3.6 2.7 5.1

: Agricultural : Mining : Manufactures

Source: calculation based on WTO International Trade Statistics, 2006. http://www.chass.utoronto.ca/link/200010/WTOtrade1.pdf

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PRATOMO Mochammad Hadi (MET06080)

Table 8. Indonesia’s Exports by groups of products, 1985–1997 (USD billions and percentage share)
Commodity Total (USD billions) 1985 18.58 1990 25.55 1991 28.99 1992 1993 1994 1995 45.37 18.0 11.4 6.6 31.3 4.4 1.6 25.4 50.6 0.8 3.3 14.8 1996 49.72 17.0 11.2 5.8 31.5 4.4 1.3 25.8 51.4 0.7 3.5 14.1 1997 53.21 16.1 11.4 4.6 29.4 3.5 1.2 24.6 42.3 0.6 3.6 12.3

Agriculture 15.9 16.2 16.5 - Food 10.0 11.2 11.3 - Agricultural raw material 6.0 5.0 5.2 4.6 4.2 Mining 70.8 48.4 42.7 37.6 31.9 - Ores and other minerals 1.5 2.6 2.9 3.0 2.7 - Non-ferrous metals 2.7 1.8 1.3 1.2 0.8 - Fuels 66.6 44.0 38.5 33.3 28.4 Manufactures 13.0 35.5 40.8 47.5 53.1 - Iron & steel 0.2 0.9 1.0 0.8 0.8 - Chemicals 3.2 2.4 2.9 2.3 2.3 - Other semimanufactures 5.5 14.6 14.1 14.7 17.7 - Machinery and transport equipment 0.5 1.4 2.3 4.3 6.0 - Textiles 1.3 4.9 6.2 8.5 7.2 - Clothing 1.8 6.5 8.0 9.5 9.7 - Other consumer goods 0.5 4.6 6.4 7.5 9.4 Other 0.2 0.0 0.0 0.0 0.0 Source: Trade Policy Review Indonesia 1998 (WTO) pp. 131

33.81 36.64 39.90 (Percentage Share) 14.9 15.0 17.6 10.2 10.8 12.8 4.9 30.5 3.1 1.0 26.4 51.8 0.8 2.5 15.8

7.6 6.3 8.2 10.6 0.0

8.4 6.0 7.6 9.6 0.0

10.0 5.7 7.4 10.0 0.0

8.7 4.2 5.6 7.4 12.2

Table 9. Indonesia’s Trade Performance Index, 1999–2003
Total Number Share in National Share in World Current Index of Exporting Exports (%) Exports (%) Position Countries Wood Products 10% 2.79% 125 7 Clothing 7% 1.70% 117 10 Textiles 5% 1.62% 112 11 Minerals 29% 2.25% 151 14 Electronics components 5% 0.43% 99 17 IT & Consumer electronics 8% 0.68% 77 20 Leather Products 2% 1.49% 84 21 Fresh Food 7% 1.50% 173 25 Miscellaneous manufacturing 5% 0.51% 124 27 Processed Food 7% 1.40% 146 28 Chemicals 7% 0.48% 127 32 Basic Manufactures 5% 0.55% 130 32 Transport Equipment 1% 0.09% 97 42 Non-electronic machinery 2% 0.18% 107 66 Source: International Trade Center, http://www.intracen.org/countries/toolpd03/idn_1.pdf Export Sector

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PRATOMO Mochammad Hadi (MET06080)

Table 10. Indonesia’s Exports by destination, 1985–1997 (USD billions and percentage share)
Country Total (USD billion)
America - United States -Other America Europe Asia - Japan - China - Middle East - South Asia - Other Asia Oceania Africa

1985
18.5 23.7 21.7 2.0 7.5 66.7 46.2 0.5 1.2 0.7 18.1

1990
25.5 14.1 13.2 0.9 12.9 70.3 42.7 3.3 2.7 0.8 20.8

1991
28.9 13.3 12.1 1.2 13.9 69.1 37.1 4.1 3.2 0.8 23.9

1992
33.8

1993
36.6

1994
39.9

1995
45.3 16.4 13.9 2.5 16.1 63.7 27.1 3.8 3.0 1.5 28.3 2.4 1.4

1996
49.7 16.0 13.7 2.3 16.7 63.3 25.9 4.1 3.0 1.8 28.5 2.7 1.3

1997
53.2 16.0 13.4 2.6 16.3 63.2 23.5 4.2 3.4 2.2 29.9 3.1 1.5

1998
48.9 17.1 14.4 2.7 17.3 60.2 18.7 3.8 3.4 2.6 31.7 3.5 1.9

2001
56.3 16.2 13.8 2.4 15.0 63.0 23.1 3.9 3.3 2.9 29.8 3.7 2.1

(Percentage Share) 14.9 16.4 16.8 13.1 14.3 14.6 1.9 2.1 2.2
15.3 66.1 31.8 4.1 3.5 0.9 25.8 15.8 64.2 30.5 3.4 3.5 1.1 25.7 16.0 63.7 27.4 3.3 2.9 1.5 28.6

1.2 1.9 2.3 2.5 2.4 2.0 0.9 0.8 1.4 1.2 1.3 1.4 Source: (1). Trade Policy Review Indonesia 1998 (WTO) pp. 138 (2). Trade Policy Review Indonesia 2003 (WTO) pp. 12 http://www.wto.org/english/tratop_e/tpr_e/tp216_e.htm

Table 11. Specialization Index of Indonesia (1999–2003)
Group of Commodities Wood Products Textiles IT & Consumer electronics Leather Products Electronic Components Minerals Clothing Miscellaneous manufacturing Chemicals Processed Foods Non-electronics machinery Basic manufactures Transport equipment Fresh food Rank 18 20 23 37 47 49 50 61 66 68 74 77 78 97 Comparative Advantage 3.26 1.89 0.80 1.65 0.50 2.62 1.98 0.60 0.56 1.62 0.21 0.64 0.11 1.74

Note: The index measures the country's revealed comparative advantage in exports according to the Balassa formula. The index compares the share of a given sector in national exports with the share of this sector in world exports. Values above 1 indicate that the country is specialized in the sector under review. Rank 1 indicates that the country has the highest specialization index in the world for the sector under review. Calculations based on COMTRADE of United Nations Statistics Division (UNSD). Source: International Trade Center (ITC) http://www.intracen.org/countries/toolpd03/idn_3.pdf

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PRATOMO Mochammad Hadi (MET06080)

Table 12. Indonesia’s Exports Performance by Ranking in Various Categories (2001–2005)
Sector description Year Number of exporting countries Ranking in net exports Ranking in share in world market Ranking in product diversification Ranking in market diversification Ranking in Value of exports Ranking in export growth Ranking in relative unit value Ranking in matching with dynamics of world demand Ranking in competitiveness effect Ranking in adaptation effect

Basic manufactures

2001 2002 2003 2004 2005

131 131 131 131 131 131 131 131 131 131 115 115 115 115 115 106 106 106 106 106

33 60 34 96 102 120 114 106 116 117 7 7 7 8 6 9 6 7 7 7

34 34 35 36 34 28 28 31 31 32 10 12 12 14 10 28 28 27 27 26

32 29 31 38 46 20 19 20 21 21 5 5 8 4 4 18 20 15 13 22

23 28 23 31 33 7 7 11 17 18 35 45 47 57 68 45 42 50 45 70

34 34 35 36 34 28 28 31 31 32 10 12 12 14 10 28 28 27 27 26 50 53 61 45 97 95 90 74 64 82 86 85 98 89 91 70

66 63 63 50 54 21 18 25 23 21 48 51 55 51 51 24 34 35 35 37 5 1 1 7 9 8 3 2 103 105 106 105 48 18 52 77 95 91 83 73 43 45 27 26 60 65 69 48 57 89 74 85 89 59 106 88 67 17 19 37 97 80 68 90 79 78 105 38

Chemicals

2001 2002 2003 2004 2005

Clothing

2001 2002 2003 2004 2005

Electronic components

2001 2002 2003 2004 2005

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PRATOMO Mochammad Hadi (MET06080)
Indonesia‘s Exports Performance by Ranking in Various Categories (Contd.)
Sector description Year Number of exporting countries Ranking in net exports Ranking in share in world market Ranking in product diversification Ranking in market diversification Ranking in Value of exports Ranking in export growth Ranking in relative unit value Ranking in matching with dynamics of world demand Ranking in competitiveness effect Ranking in adaptation effect

Fresh food

2001 2002 2003 2004 2005

177 177 177 177 177 81 81 81 81 81 93 93 93 93 93 152 152 152 152 152

23 18 16 14 13 10 11 12 12 12 5 6 6 6 6 12 12 13 19 19

19 18 19 19 18 22 22 23 23 23 11 16 17 16 14 13 13 15 28 19

65 62 76 84 75 2 5 4 6 7 65 69 68 65 70 51 33 33 19 20

65 66 60 58 59 39 38 38 42 47 43 43 40 35 29 80 82 86 38 77

19 18 19 19 18 22 22 23 23 23 11 16 17 16 14 13 13 15 28 19 106 118 147 119 86 82 82 78 41 62 60 58 42 78 65 52

47 49 55 50 46 28 32 34 37 35 23 28 33 35 28 85 82 79 72 75 40 24 41 87 48 54 111 106 102 112 105 63 8 4 1 22 83 61 27 44 70 86 90 83 75 80 72 67 39 62 55 51 17 34 35 29 96 76 43 64 72 90 90 81 55 104 90 68

IT & Consumer electronics

2001 2002 2003 2004 2005

Leather products

2001 2002 2003 2004 2005

Minerals

2001 2002 2003 2004 2005

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PRATOMO Mochammad Hadi (MET06080)
Indonesia‘s Exports Performance by Ranking in Various Categories (Contd.)
Sector description Year Number of exporting countries Ranking in net exports Ranking in share in world market Ranking in product diversification Ranking in market diversification Ranking in Value of exports Ranking in export growth Ranking in relative unit value Ranking in matching with dynamics of world demand Ranking in competitiveness effect Ranking in adaptation effect

Miscellaneous manufacturing

2001 2002 2003 2004 2005

130 130 130 130 130 116 116 116 116 116 153 153 153 153 153 118 118 118 118 118

8 8 9 13 12 107 104 101 104 104 15 12 12 9 10 8 9 8 8 8

25 25 26 27 28 39 39 40 41 39 22 18 19 18 17 14 15 16 16 16

50 57 61 50 57 60 76 87 69 46 60 79 93 88 88 22 21 16 11 13

50 51 35 40 35 67 75 71 64 62 12 20 28 29 18 1 1 1 1 2

25 25 26 27 28 39 39 40 41 39 22 18 19 18 17 14 15 16 16 16 88 96 98 80 18 37 26 25 22 34 43 35 102 108 108 108

22 30 34 31 26 22 21 30 33 26 59 46 43 22 42 49 50 52 47 46 32 24 16 20 89 98 96 86 67 66 60 44 138 68 132 113 42 78 42 30 25 59 36 40 19 33 7 24 24 20 19 24 60 79 95 74 61 45 21 58 102 107 103 105 82 108 48 30

Non-electronic machinery

2001 2002 2003 2004 2005

Processed food

2001 2002 2003 2004 2005

Textiles

2001 2002 2003 2004 2005

49

PRATOMO Mochammad Hadi (MET06080)

Indonesia‘s Exports Performance by Ranking in Various Categories (Contd.)
Sector description Year Number of exporting countries Ranking in net exports Ranking in share in world market Ranking in product diversification Ranking in market diversification Ranking in Value of exports Ranking in export growth Ranking in relative unit value Ranking in matching with dynamics of world demand Ranking in competitiveness effect Ranking in adaptation effect

Transport equipment

2001 2002 2003 2004 2005

110 110 110 110 110 120 120 120 120 120

96 92 89 84 83 4 4 4 5 7

46 43 43 45 39 7 7 10 13 13

17 10 25 11 16 43 39 40 36 45

14 9 15 19 16 22 24 24 26 16

46 43 43 45 39 7 7 10 13 13 76 99 106 105 36 40 46 24

21 22 24 28 32 32 36 41 40 40 28 18 46 105 4 7 10 108 117 119 119 28 16 55 42 26 21 34 37 29 88 81 75 63

Wood products

2001 2002 2003 2004 2005

Source: International Trade Center (ITC)

http://www.intracen.org/menus/countries.htm

50

PRATOMO Mochammad Hadi (MET06080)

Appendix B: Figures Figure 1. Four Macroeconomic Indicators (Real GDP, Real Exports, Real GFCF and Labor) of Indonesia (1980–2004)

2.00E+11 1.80E+11 1.60E+11 1.40E+11 1.20E+11 1.00E+11 8.00E+10 6.00E+10 4.00E+10 80 82 84 86 88 90 92 94 96 98 00 02 04 GDP

8.0E+10 7.0E+10 6.0E+10 5.0E+10 4.0E+10 3.0E+10 2.0E+10 80 82 84 86 88 90 92 94 96 98 00 02 04 EXP

6.0E+10

1.10E+08 1.00E+08 9.00E+07

5.0E+10

4.0E+10
8.00E+07

3.0E+10
7.00E+07

2.0E+10

6.00E+07 5.00E+07

1.0E+10 80 82 84 86 88 90 92 94 GFCF 96 98 00 02 04

80

82

84

86

88

90

92

94

96

98

00

02

04

LAB

Note:

- Value in y-axis stated in USD 2000 constant term except for labor which stated in unit. - Value in x-axis represents period of data from 1980 to 2004

51

PRATOMO Mochammad Hadi (MET06080) Figure 2. Average Exports Composition by Commodities from 1988 to 2005
Animal and animal products Vegetable products Animal or vegetable fats Prepared foodstuffs

3% 9% 1% 5%

12%

Mineral products

3% 1% 1% 4%
Chemical products Plastics and rubber Hides and skins Wood and wood products

3% 10%

Wood pulp products Textiles and textile articles Footwear, headgear

1% 1% 2% 3% 31% 0% 3% 2% 2% 2%

Articles of stone, plaster, cement, asbestos Pearls, precious or semi-precious stones, metals Base metals and articles thereof Machinery, mechanical appliances and electrical equipment Transportation equipment Instruments—measuring, musical Arms and ammunition Miscellaneous manufactured articles Works of art

Source: http://www.adb.org/Documents/Books/Key_Indicators/2006/default.asp

Figure 3. Exports by Commodities from 1988 to 2005
Works of art

90,000.00
Miscellaneous manufactured articles

80,000.00 70,000.00

Arms and ammunition Instruments—measuring, musical Transportation equipment Machinery, mechanical appliances and electrical equipment Base metals and articles thereof Pearls, precious or semi-precious stones, metals

Value (in million US$)

60,000.00 50,000.00 40,000.00 30,000.00 20,000.00 10,000.00 -

Articles of stone, plaster, cement, asbestos Footwear, headgear Textiles and textile articles Wood pulp products Wood and wood products Hides and skins Plastics and rubber Chemical products Mineral products Prepared foodstuffs

19 88

19 90

19 92

19 94

19 96

19 98

20 00

20 02

20 04

Animal or vegetable fats Vegetable products Animal and animal products

Year

Source: http://www.adb.org/Documents/Books/Key_Indicators/2006/default.asp

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