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Journal of Economic Policy Reform

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The relation between capital formation

and economic growth: evidence from
sub-Saharan African countries
a
Eberechukwu Uneze
a
Centre for the Study of the Economies of Africa, Abuja, Nigeria.
Published online: 10 Jun 2013.

To cite this article: Eberechukwu Uneze (2013) The relation between capital formation and
economic growth: evidence from sub-Saharan African countries, Journal of Economic Policy Reform,
16:3, 272-286, DOI: 10.1080/17487870.2013.799916

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 Journal of Economic Policy Reform, 2013
Vol. 16, No. 3, 272–286, http://dx.doi.org/10.1080/17487870.2013.799916

The relation between capital formation and economic growth: evidence

from sub-Saharan African countries
Eberechukwu Uneze*

Centre for the Study of the Economies of Africa, Abuja, Nigeria

This paper examines the causal relationship between capital formation and economic
growth in Sub-Saharan African countries using recent panel cointegration and
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causality testing techniques. We find that causality is bi-directional, suggesting that

higher economic growth leads to higher capital formation and that in turn, increases in
capital formation results in higher economic growth. These results hold irrespective of
whether capital formation is measured with private fixed capital formation or by gross
capital formation.
Keywords: capital formation; economic growth; sub-Saharan Africa
JEL Classifications: C33, E22, O16

1. Introduction
Sub-Saharan Africa’s (SSA’s) growth performance has for sometime been the subject of
numerous empirical studies. With a few exceptions, such as Botswana and Mauritius,
SSA generally had a disappointing record of economic growth, before the strong recent
growth performance (Lin and Rosenblatt 2012). For example, between 1985 and 1990,
average annual growth in real Gross Domestic Product (GDP) per capita was
0.9% and
between 1991 and 2007 it was 1.8%. Several reasons have been given for SSA’s poor
growth performance, including high population growth, poor export performance, low
levels of capital formation1, and ethnic conflicts (Easterly and Levine 1997; Fosu 2001;
Commission for Africa 2005; Gomanee, Girma, and Morrissey 2005). Collier and Gun-
ning (1999) argued that the major cause of the poor growth performance was fundamen-
tally low investment. In SSA, average annual capital formation (as a percentage of GDP)
between 1985 and 1990 was around 16.1% and between 1991 and 2007 it was 18.6%.
Again, the main exceptions are Botswana, which recorded 26.5%, and Mauritius, which
reached 27.6%, between 1985 and 2007. In effect, this low-capital formation and slow-
growth condition might imply that capital formation precedes economic growth. The con-
verse is also likely to be true as low-capital formation in some countries may have been
due to slow growth. For example, in the accelerator model, rapid economic growth gener-
ates high profit expectations, which then encourages businesses to build more factories
and buildings as well as install additional machinery. Also, the endogenous growth theo-
ries may be at work so that capital accumulation may not cause growth in the Granger
sense if factors other than investment in physical capital have a greater role in the deter-
mination of long-run growth.

*Email: euneze@cseaafrica.org

Ó 2013 Taylor & Francis

 Journal of Economic Policy Reform 273

These competing positions raise important questions for SSA countries that have been
attempting to implement appropriate macroeconomic policies aimed at accelerating eco-
nomic growth and the rate of capital accumulation. Firstly, should SSA countries pursue
growth policies that aim to increase the level and rate of capital formation? Secondly,
should SSA policy-makers promote capital formation in order to achieve rapid economic
growth? Yet, the ultimate solution to this dilemma may lie outside policies that indepen-
dently target economic growth or capital formation. Thus, a third question arises: should
SSA countries simultaneously promote capital formation and economic growth? Certainly,
the answers to these questions are of critical importance and can be determined only
empirically.
The objective of the paper is to investigate the causal relationship between capital for-
mation and economic growth for a panel of 13 SSA countries. A number of studies have
empirically examined the causal relationship between capital formation and economic
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growth. Blomstrom, Lipsey, and Zejan (1996) and Bose and Haque (2005) examined the
direction of causality between capital formation and economic growth using the Granger–
Sims causality framework. However, these studies have some methodological difficulties. It
is well known that the traditional testing technique is not suitable for panel data analysis as
it does not consider the inherent heterogeneity across countries. Another limitation with the
approach is that they fail to establish from the onset whether a long-run relationship exists
between capital formation and economic growth. This paper seeks to address these issues.
The goal of this paper is achieved in two steps. To begin with, we test the variables for
unit root and cointegration. This is to ensure that capital formation and economic growth
are integrated of order one and also related in the long run. The long-run relationship is
particularly crucial for two reasons. Firstly, it is because two variables that are integrated
of order one may still drift far apart. Secondly, it is that two integrated variables (I(1)) can-
not cause each other in the long run unless they are cointegrated. In the final step, we
apply the panel Granger causality framework developed by Hurlin and Venet (2001) to
determine the direction of causality between capital formation and economic growth.
This paper makes three important contributions to the empirical literature on capital
formation and economic growth. The first contribution is the application of the Hurlin
and Venet (2001) to the capital formation and growth relationship. While several authors
have used panels of countries to study the relationship between capital formation and
economic growth, there does not appear to be any empirical paper that has applied the
Hurlin and Venet (2001) technique that is specifically developed for panel data analysis.
The main advantage of using this technique is that it helps to address the problem of
sample heterogeneity. The second contribution of this paper is a methodological one. This
paper uses recent panel cointegration tests to determine the existence of short-run causa-
tion between capital formation and economic growth before applying the panel causality
test. Lastly, it improves on Hurlin and Venet (2001) testing approach by estimating a
specification that distinguishes between short-run and long-run causation.
The rest of the paper is structured as follows: Section 2 discusses the relevant empiri-
cal literature; Section 3 discusses the methodology; Section 4 examines the data; Section 5
presents the results, while Section 6 concludes with some policy implications.

2. A brief review of empirical literature

We first review selected studies on the causal relationship between capital formation and
economic growth. De Long and Summers (1991) examined the relationship between
equipment investment and GDP per worker growth for a sample of 61 countries over
 274 E. Uneze

1960–1985. Based on a regression in which GDP per worker growth was the dependent
variable, they concluded that higher equipment investment is a consequence of faster eco-
nomic growth. Other studies, for example, Mankiw, Romer, and Weil (1992); Kormendi
and Meguire (1985); Levine and Renelt (1992); and Islam (1996), reach similar conclusion
that gross domestic investment as a share of GDP has a significant positive effect on
growth. More recently, Lauthier and Moreaub (2012) examined the relationship between
domestic investment and foreign direct investment (FDI), and found that FDI follows
domestic investment.2 The major drawback to these studies is that they do not test for cau-
sality, at least in the Granger sense. In another recent paper, Bond, Leblebicioglu, and
Schiantarelli (2010) found a strong evidence of a positive relationship between investment
as a share of GDP and long-run growth rate of GDP per worker for 75 countries, including
OECD and non-OECD samples. We differ from Bond, Leblebicioglu, and Schiantarelli
(2010) by focusing on SSA countries and examining whether there is a bi-directional cau-
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sality between capital formation and growth. In contrast to the above literature, studies
based on more formal methods of testing causality, for example, Blomstrom, Lipsey, and
Zejan (1996), and Bose and Haque (2005), found that causality is unidirectional, from eco-
nomic growth to capital formation. While Blomstrom, Lipsey, and Zejan (1996) examined
the direction of causation between fixed capital formation and economic growth, Bose and
Haque (2005) examined causality between public investment in transport and communica-
tion, and economic growth. Similarly, Easterly and Levine (2001) found no evidence to
suggest that capital accumulation results in faster economic growth. For India, Dash and
Sahoo (2010) examined the relation between physical and social infrastructure, and eco-
nomic growth, and found a unidirectional causality from infrastructure development and
human capital to output growth. Again, with the exception of Bond, Leblebicioglu, and
Schiantarelli. (2010), these studies do not distinguish whether the unidirectional causality
is a feature of the short run or long run. It may be the case that there exist bi-directional
causality, both in the short-run and long-run and can only be ascertained if appropriate
estimation technique is used. In addition, these studies do not address country heterogene-
ity that result in different coefficient slopes.

3. Methodology
3.1. Panel unit root
In this paper, we employ two different panel unit root tests, one proposed by Levin et al.
(2002) [henceforth LLU] and the other by Im, Pesaran, Shin (2003) [henceforth IPS].
Both tests are developed for dynamic panels and are based on the following regression:
X
n
Dyit ¼ ai þ qi yit
1 þ wk Dyit
k þ pi t þ eit ð1Þ
k¼1

The main difference between the tests lies in the assumption made aboutqi . Under
LLU test, qi is restricted to be homogenous across all units of the panel. For both tests,
the null hypothesis is that all the series are non-stationary. However, they differ under the
alternative hypothesis. The null and the alternative hypotheses under LLU are:
H0 : qi ¼ 0 for all i

HA : qi  0 for all i
 Journal of Economic Policy Reform 275

The IPS test provides separate estimation for each i unit, allowing different specifica-
tions of the parametric values and the residual variance under the alternative hypothesis
(that is, a fraction of the series in the panel has no unit root). This is in contrast with the
LLU test, which assumes that all the series are stationary. The null and the alternative
hypotheses under IPS are:
H0 : qi ¼ 0 for all i

HA : q\0 for at least one i

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3.2. Panel cointegration

The cointegration tests used in this paper are the panel residual-based test developed by
Pedroni (1999) and the ADF test developed by Kao (1999). While Pedroni’s tests allow
considerable heterogeneity, Kao’s test imposes homogenous cointegrating vectors and
autoregressive (AR) coefficients. The cointegration test developed by Pedroni (1999) is
of two categories. The first category comprises four within dimension-based tests. These
tests pool the AR coefficients across different sections of the panel. In practice, the tests
are implemented by calculating the average test statistics for cointegration in the times
series framework across the different sections. The second category includes three tests
that are based on between dimension effects, with an alternative hypothesis of individual
AR coefficients. This involves averaging the AR coefficients for each of the panel for
unit root test on the residuals. Additional information on Pedroni’s within and between
dimensions tests is given in the Appendix.

3.3. Panel Granger causality

We follow the panel causality testing framework developed by Hurlin and Venet (2001).
This technique draws on the procedure developed by Granger (1969) and further
expanded by Sims (1972). For two stationary variables, x and y, observed over T periods
and on N individuals, Hurlin and Venet (2001) propose the following panel data Granger
causality framework3:
Xp X
p
ðkÞ
yit ¼ cðkÞ yit
k þ bi xit
k þ tit ð2Þ
k¼1 k¼0

ðkÞ
where, the AR coefficients cðkÞ and the regression coefficient slopes bi are fixed. It is
also assumed that the AR coefficients cðkÞ are identical for all countries, while the regres-
ðkÞ
sion coefficient slopes bi can vary across countries.
This approach takes into account the different sources of heterogeneity across
countries. As argued by Hurlin and Venet (2001), heterogeneity arises from two main
sources: The first source, which is fairly standard, comes from the heterogeneous inter-
cepts across countries. However, such heterogeneity is controlled by the introduction of
individual effects in the fixed effects model. The second source of heterogeneity which is
very critical, but often ignored in the literature arises from the heterogeneous regression
coefficient slopes. For example, it may be possible that, for some countries, the
introduction of past values of x improves the forecast on y, and for others there is no
 276 E. Uneze

improvement. Ignoring this source of heterogeneity can lead to wrong conclusions on the
causality relationships. In this case, Hurlin and Venet (2001) propose four types of cau-
sality relationships. These relationships distinguish between two sub-groups of countries
according to the causality between x and y, and are based on F-test (Wald statistic).
The first is the homogenous non-causality (HNC) relationship, which involves testing
the hypothesis that there are no individual causal relationships. If the F-statistic is insig-
nificant, the HNC hypothesis is rejected, implying that causality exists for at least one
member of the group. On the other hand, if the HNC hypothesis is accepted, it means
that x is not causing yin all the countries in the panel. In this case, the testing process
will not continue. With this outcome, one will proceed to the second case, which
involves testing the homogenous causality (HC) hypothesis.
The HC relationship, which corresponds to the standard homogeneity test, involves
testing the hypothesis that the regression slope coefficients are identical and different
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from zero. If the F-statistic is not significant, the HC causality hypothesis is accepted.
This means that x is causing y in all the countries in the panel and that the process is
completely homogenous, in which case no further testing will be necessary. But if the
causality hypothesis is rejected, the testing procedure will proceed to the non-homoge-
nous testing.
The third case involves testing the heterogeneous non-causality hypothesis (HENC).
There are two types of tests for this hypothesis. The first is an individual test and con-
strains the coefficient on the lagged explanatory variable to zero. The second is a joint
test for a sub-group in the sample, and it tests the hypothesis that there is no causality
relationship for a subgroup of countries. If the HENC is accepted (i.e. if the F-statistic is
insignificant), it will then imply that there exists a sub-group for which x does not cause
y. Rejection of the HENC hypothesis implies that there exist causal relationships between
x and y for all countries in the panel. The last case is the heterogeneous causality hypoth-
esis. This is similar to the HC hypothesis only that the dynamics of y are heterogeneous.
But the heterogeneity does not affect the causality results. The Wald statistic is presented
in the Appendix.
However, Equation 2 is inappropriate if the variables are non-stationary and cointe-
grated. As argued by Granger and Lin (1995), two integrated series cannot cause each
other in the long run unless they are cointegrated. For non-stationary – I(1) and cointe-
grating variables, Hendry, Pagan, and Sargan (1984) and Johansen (1988) proposed a
Granger causality test within the framework of the error correction model (ECM). This
involves including the lagged values of the ECM from the cointegration equation in the
VECM of per capita growth and capital formation so that Equation 2 is re-specified as
follows:
Xp X
p
ðkÞ
Dyit ¼ kðkÞ Dyit
k þ ui Dxit
k þ gsit
1 þ eit ð3Þ
k¼1 k¼0

wheresit
1 is the lagged value of the error correction term from the cointegrating
regression.
The null hypotheses to be tested are modified to include the coefficient (sit
1 , repre-
senting the speeds of adjustment to the equilibrium) on the error correction terms. This
means that there are now two dimensions of causation for per capita growth and capital
formation, either through the lagged terms (Dxit
k Þ, comprising DPCGit
i and DCFit
j or
through the lagged error correction term, sit
1 . The lagged variables represent the short-
run dimension while lagged residuals represent the long-run dimension. The latter source
 Journal of Economic Policy Reform 277

of causation is not detected by the Granger causality testing procedure of Hurlin and
Venet (2001). Causality exists if any of these dimensions is significant. In the short run,
causality exists only when the coefficients on the lagged terms of economic growth and
capital formation are significant and different from zero.
Equation 3 is conceptually appealing because it makes a distinction between short-run
and long-run causality within a panel causality testing framework. This way it is easy for
one to infer if there is causality in the short run or in the long run (or in both periods).
Thus, we improve on Hurlin and Venet (2001) by taking into account, the lagged values
of the error correction term from the cointegrating regression.

4. Data
We use World Bank data on capital formation and economic growth for 13 countries4 in
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SSA, covering the period 1985–2007. The 13 countries selected were those SSA coun-
tries for which data on fixed capital formation and economic growth were available with-
out gaps (balanced panel). For each country, we use two (2) measures of capital
formation. First is private fixed capital formation as a percentage of GDP, and second is
gross capital formation as a percentage of GDP. The second measure serves as a check
on the robustness of our results. Though the marginal efficiency of investment, which is
low in SSA, may affect the relationship between capital accumulation and growth, we do
not incorporate this effect directly into this paper.5 Consistent with the literature, we mea-
sure economic growth with real GDP per capita. For example, Fowowe (2011) used the
same to examine the finance-growth nexus in SSA, while Bond, Leblebicioglu, and Schi-
antarelli. (2010) used growth rate of GDP per worker. The 13 countries are listed in the
end notes while the definitions of variables are given in the Appendix.

5. Results
5.1. Unit root and cointegration
For the empirical stage of this study, we begin by conducting the unit root tests on the
variables, both in levels and in first difference. The results of the LLU and IPS tests pre-

Table 1. Panel unit root tests.

H0: Unit root Tests

LLU IPS Decision

Level
PCG 1.9976[0.9771]
0.9502[0.1710] Accept H0
PCF 0.1069[0.5424]
0.3775[0.3529] Accept H0
GCF 3.2887[0.9995]
0.3314[0.3702] Accept H0
First difference
ΔPCG
6.4839[0.0000]⁄
2.7645[0.0029]⁄ Reject H0
ΔPCF
1.6459[0.0499]⁄⁄
6.3224[0.0000]⁄ Reject H0
ΔGCF
8.5434[0.0000]⁄
9.4132[0.0000]⁄ Reject H0

Notes: All tests include individual effects and trends. [ ] are P-values. ⁄indicates that results are significant at
the 1% level, while ⁄⁄indicates 5% significance levels.
 278 E. Uneze

sented in Table 1 show that all the variables, PCG, PCF, and GCF, are non-stationary as
the null hypothesis that the variables have unit root is not rejected. The null hypothesis
that the first difference of the variables contain unit root is rejected for both tests. These
results imply that the variables are integrated of order 1, I(1). This is a necessary condi-
tion for cointegration in a two-variable context.
We next conduct panel cointegration tests in which Pedroni’s seven (7) residual based
tests and Kao’s ADF test are implemented. The tests are conducted for PCG and PCF on
one hand, and PCG and GCF on the other. The results of both tests are summarized in
Table 2. The null hypothesis of no cointegration between private fixed capital formation
and real per capita GDP growth is rejected at the 1% significance level for both tests,
implying that there is a long-run stable relationship between them. For gross capital for-
mation and real per capita GDP growth, we find that five out of the seven Pedroni’s tests
show that PCG and GCF are cointegrated. This is in addition to Kao’s ADF test, which
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rejects the null hypothesis of no cointegration. On the basis of these results, we conclude

Table 2. Panel cointegration tests.

H0: No cointegration between PCF and PCG

Pedroni cointegration test

Panel v-statistic 2.22[0.0131]⁄⁄
Panel rho-statistic
11.66[0.0000]⁄
Panel PP-statistic
9.79[0.0000]⁄
Panel ADF-statistic
6.22[0.0000]⁄
Group rho-statistic
7.47[0.0000]⁄
Group PP-statistic
12.13[0.0000]⁄
Group ADF-statistic
6.84[0.0000]⁄
Decision Reject H0
Kao cointegration test
ADF t-statistic
2.52[0.0059]⁄
Decision Reject H0

H0: No cointegration between GCF and PCG

Pedroni cointegration test
Panel v-statistic
2.06[0.9804]
Panel rho-statistic
1.69[0.0452]⁄⁄
Panel PP-statistic
4.03[0.0000]⁄
Panel ADF-statistic
2.63[0.0042]⁄
Group rho-statistic 0.16[0.5651]
Group PP-statistic
2.87[0.0020]⁄
Group ADF-statistic
2.01[0.0220]⁄
Decision Reject H0
Kao cointegration test
ADF t-statistic 2.64[0.0041]⁄
Decision Reject H0

Notes: Pedroni tests include deterministic intercept and trend, while Kao test is conducted without a trend.
⁄
indicates significance at the 1% level, while ⁄⁄indicates significance at the 5% level.
 Journal of Economic Policy Reform 279

that a long-run stable relationship exists between economic growth and the two measures
of capital formation; private fixed capital formation and gross capital formation.
The existence of a long-run stable relationship between capital formation and eco-
nomic growth suggests that there must be Granger causality at least uni-directional, but it
does not indicate the direction of causality between the variables.

5.2. Panel causality

Having found a cointegrating relationship between capital formation and economic
growth, we turn to the panel Granger causality testing. This involves estimating Equation
3 in order to determine the direction of long-run causality between the variables.6
As in most panel data analysis, we consider the fixed effects regression method, which
allows for variation within each country intercept. As mentioned in the methodology sec-
tion, we use this method to control for the first source of heterogeneity across countries.
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We use four lags for each of the variables (except the error correction term) considered.
We start the Granger panel causality test with the HNC test. The results presented in
the first half of Table 3, testing the hypothesis that there is no HNC causality (both in the
short run and long run) between economic growth and private fixed capital formation is
rejected at the 1% significance level. Though causality runs in both directions, it is even
Table 3. HNC test.

Causality test between PCF and PCG (A)

Lags Fhnc p-value

H0: No PCG → PCF

1 6.40⁄ 0.0004
2 3.71⁄ 0.0059
3 2.64⁄⁄ 0.0242
4 4.02⁄ 0.0008
H0: No PCF → PCG
1 33.99⁄ 0.0000
2 16.02⁄ 0.0000
3 10.72⁄ 0.0000
4 7.80⁄ 0.0000

Causality test between GCF and PCG (B)

H0 : No PCG → GCF
1 11.85⁄ 0.0000
2 6.61⁄ 0.0000
3 4.34⁄ 0.0009
4 3.70⁄ 0.0016
H0 : No GCF → PCG
1 31.49⁄ 0.0000
2 14.74⁄ 0.0000
3 10.64⁄ 0.0000
4 7.10⁄ 0.0000

Notes: ⁄indicates that results are significant at the 1% level, while ⁄⁄

indicates 5% significance level.
 280 E. Uneze

stronger from capital formation than from economic growth. This results hold for
different lag lengths.
The results presented in the second half of three, using gross capital formation show
similar results – causality runs in both directions in the short run and the long run. What
this means is that for at least one country, there is a bi-directional Granger causality
between capital formation and economic growth.
With the rejection of HNC hypothesis, we turn to the second case of the panel causal-
ity testing which involves testing the HC hypothesis. Here, we test the joint hypothesis
that the regression slope coefficients are identical and different from zero (short run) and
that the ECM (long run) is different from zero. The results are presented in Table 4. In
the first half of Table 4, the HC hypothesis is tested between economic growth and pri-
vate fixed capital formation. The Fhc statistic is insignificant both for when private fixed
capital formation and economic growth are each the dependent variable. Thus, we con-
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clude that there is a homogeneous bi-directional causality between private fixed capital
formation and economic growth.
The findings presented in the second half of Table 4 are generally consistent with the
first part. In this half, capital formation is measured by gross capital formation. Again,
the HC hypothesis is not rejected, with causality running from both gross capital forma-
tion and economic growth. With this evidence, we conclude that there is a homogeneous
Table 4. Homogenous causality (HC) test.

Causality test between PCF and PCG

Lags Fhc p-value

H0: PCG → PCF

1 0.42 0.5200
2 0.55 0.5759
3 0.33 0.8068
4 0.71 0.5803
H0: PCF → PCG
1 0.36 0.5472
2 1.87 0.1557
3 0.75 0.5261
4 1.77 0.1364

Causality test between GCF and PCG

H0: PCG → GCF
1 0.77 0.3807
2 0.21 0.8086
3 0.65 0.5819
4 0.78 0.5386
H0: GCF → PCG
1 1.04 0.3086
2 0.69 0.5018
3 0.35 0.7886
4 0.58 0.6759
 Journal of Economic Policy Reform 281

bi-directional causality (both in the short run and long run) between capital formation
and economic growth irrespective of whether former is measured by private fixed capital
formation or by gross capital formation.
In summary, the HNC and HC tests suggest that HC runs from both capital formation
and economic growth, and the bi-directional causality between capital formation and
economic growth is a feature of both the short run and the long run.
To further check the validity of our results, we re-examine the causal relationship
between private fixed capital formation and economic growth using exactly the specifica-
tion (Equation 6) suggested by Hurlin and Venet (2001). The results are presented in
Table A1 in the Appendix and are somewhat different from those derived from our pre-
ferred specification. Another distinguishing feature of our results is that the F-statistics
(except one) at all lags are significant at the 1% level. It is then possible to conclude that
excluding the error correction term from the causality testing framework when there is
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evidence of cointegration could bias the results.

6. Conclusion and policy implications

The study examined the causal relationship between capital formation and economic
growth in a panel of 13 SSA countries using a wide range of econometric testing
approaches. Our main results are as follows. We find that there is a cointegrating relation-
ship between capital formation and economic growth, irrespective of whether the former
is measured with either private fixed capital formation or gross capital formation.
Secondly, we are able to establish that there is a homogenous bi-directional causality
between capital formation and economic growth in the short run and the long run. These
findings suggest that for the 13 SSA countries in the panel both variables Granger-cause
each other.
The implication of these findings is that any autonomous growth of GDP, for exam-
ple, because of substantial rise in prices of the country’s exports, for a number of years,
or series of bumper crops, could boost capital formation. In addition, growth policies that
tend to encourage or strengthen export processing zones could result in an increase in
capital formation. For example, these countries could increase output and exports by
offerings tax breaks to industries in the export processing zones. This could then increase
the rate and level of capital formation.

Acknowledgement
The author would like to thank three anonymous referees for the helpful comments. All the
remaining errors are those of the author.

Notes
1. This is the same as domestic investment as a percentage of GDP (also see definition of vari-
ables in the Appendix).
2. Other related studies on capital accumulation and economic growth include: Adams (2009);
Oketch (2006); Qin et al. (2006).
3. Hurlin and Venet (2001) applied the methodology to the causal relationship between financial
deepening and economic growth for a balanced panel of 16 SSA countries. Some studies that
have applied the Hurlin and Venet (2001) approach include: Fowowe (2011); Craigwell and
Wright (2011); and Nicolini and Paccagnin (2011).
4. Mauritius, Congo Rep., Malawi, Madagascar, South Africa, Cameroon, Senegal, Uganda, Bots-
wana, Kenya, Ghana, Zambia and Mali.
 282 E. Uneze

5. As Bond, Leblebicioglu, and Schiantarelli (2010) would argue, investment embodies the dee-
per factors that influence growth outcomes.
6. The individual tests conducted on the coefficient of the error correction terms are also signifi-
cant, but have not been reported in this paper.

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Appendix
I. Unit root tests
The Im, Pesaran, Shin (2003) test (IPS t-bar test) is based on the null hypothesis of a unit roots
and follows the augmented Dickey–Fuller approach which relies on the following equation:

X
pi
Dyit ¼ qi yt
1 þ uij Dyit
j þ ai þ ci t þ eit for t ¼ 1 . . . T ; i ¼ 1 . . . N
j¼1

On the other hand, the test proposed by Hadri (2000) is based on the null of stationarity and
the following regression:
X
T
yit ¼ ai þ ci t þ lit þ eit
t¼1

II. Cointegration tests

The Pedroni test statistics include:
!
1
N X
X T X
N X
T
Zqw ¼ L
2
11i ^e2it
1 L
2 eit
1 D^eit
k^i Þ:Panel Rho
11i ð^
i¼1 t¼1 i¼1 t¼1

!1=2
X
N X
T X
N X
T
  
2
Ztw ¼ ~sNT L
2
11i ^e2
it
1 L
2 eit
1 D^eit : Panel ADF
11i ^
i¼1 t
1 i¼1 t¼1
 284 E. Uneze
!
1=2
X
N X
T X
N X
T  
w
Zpp ¼ r~ 2
L
2 ^e2it
1 L
2 ^e it
1 D^
e it
^i : Panel PP
k
11i 11i
i¼1 t¼1 i¼1 t¼1

!
1
N X
X T
Zvw ¼ L
2
11i ^e2it
1 : PanelV
i¼1 t¼1

!
1
X
N X
T T 
X 
ZqB ¼ ^e2it
1 ^eit
1 D^eit
k^i : Group Rho
i¼1 t¼1 t¼1
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!
1
X
N X
T T 
X 
ZtB ¼ r^2i ^e2it
1 ^eit
1 D^eit
k^i : Group ADF
i¼1 t¼1 t¼1

!
1
X
N X
T X
T
  
B
Zpp ¼ ^s2^e2
it
1 ^eit
1 D^eit :Group PP
i¼1 t¼1 t¼1

with,
ki  X
^ 1X s t
k¼ 1
l^ l^ ;
T s¼1 ki þ 1 t¼sþ1 it it
s

1 X t
^s2i ¼ l^2 ; r^2 ¼ s2i þ 2k^i ;
T t¼sþ1 it

r~i ¼ ^s2i þ 2k^i

1X N
^
2 r^2 ;
r~2NT ¼ L
T i¼1 11i i

1 X t
1 X t
^s2
i ¼ l^2 ; ^s2
NT ¼ ^s2 ;
T t¼sþ1 it T t¼sþ1 it
 Journal of Economic Policy Reform 285

X ki  X
^211i ¼
T
2X s t
L g^2it þ 1
g^ g^ ;
t¼1
T s¼1 ki þ 1 t¼sþ1 it it
s

X
Ki
^eit ¼ q^^eit
1 þ l^it ¼ q^^eit
1 þ c^ik D^eit
k þ l^it ;
k¼1

X
M
Dyit ¼ ^
bmi DXmit þ g^it ;
m¼1
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pffiffiffiffiffiffiffiffiffiffiffi
tADF þ 6N r^v =2^ rov
Kao’s ADF statistic : ADF ¼ pffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
ffi
r^20v =ð2^ r2v Þ þ 3^ r2v =ð10^ r20v Þ

III. Panel causality test – F Statistics

Case 1: HNC hypothesis test
ðRSS2
RSS1 Þ=ðNpÞ
Fhnc ¼
RSS1 =½NT
N ð1 þ pÞ
p

Case 2: HC hypothesis test

ðRSS3
RSS1 Þ=½pðN
1Þ
Fhc ¼
RSS1 =½NT
N ð1 þ pÞ
p

Case 3: HENC (1) hypothesis test

ðRSS2:i
RSS1 Þ=p
i
Fhenc ¼
RSS1 =½NT
N ð1 þ 2pÞ þ p

Case 4: HENC (2) hypothesis test

ðRSS4
RSS1 Þ=ðnnc pÞ
Fhenc ¼
RSS1 =½NT
N ð1 þ pÞ
nc p

Definition of Variables (Source: African Development Indicators 2011)

Real GDP per Capita Growth (annual %) GDP per capita is gross domestic product divided
by midyear population. GDP at purchaser’s prices is the sum of gross value added by all resident
producers in the economy plus any product taxes and minus any subsidies not included in the
value of the products. It is calculated without making deductions for depreciation of fabricated
assets or for depletion and degradation of natural resources. Annual percentage growth rate of
GDP per capita is based on constant local currency.
Gross capital formation (formerly gross domestic investment) consists of outlays on additions
to the fixed assets of the economy plus net changes in the level of inventories. Fixed assets include
land improvements (fences, ditches, drains, and so on); plant, machinery, and equipment purchases;
 286 E. Uneze

and the construction of roads, railways, and the like, including schools, offices, hospitals, private
residential dwellings, and commercial and industrial buildings. Inventories are stocks of goods held

Table A1. Panel Causality Tests (Level without ECM).

Homogenous non causality between PFC and PCG

Lags Fhnc p-value

No PCG → PCF
1 5.05⁄ 0.0070
2 2.95⁄⁄ 0.0331
3 2.83⁄⁄ 0.0252
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4 2.56⁄⁄ 0.0498
No PCF → PCG
1 5.91⁄ 0.0031
2 2.43⁄⁄⁄ 0.0656
3 1.67 0.1576
4 1.73 0.1290

Homogenous causality between PFINV and PCG

PCG → PCF
1 0.02 0.8805
2 0.09 0.9150
3 0.04 0.9907
4 0.23 0.9221
PCF → PCG
1 0.81 0.3687
2 0.42 0.6594
3 0.68 0.5633
4 1.07 0.3742

Notes:⁄indicates that results are significant at the 1% level, while ⁄⁄

and ⁄⁄⁄
indicate 5 and 10% significance
levels, respectively.

by firms to meet temporary or unexpected fluctuations in production or sales, and “work in pro-
gress.” According to the 1993 SNA, net acquisitions of valuables are also considered capital for-
mation.
Gross fixed capital formation, private sector (% of GDP) covers gross outlays by the private
sector (including private non-profit agencies) on additions to its fixed domestic assets.