Exchange rate depreciation and the trade balance in

South Africa
Lawrence Edwards and Owen Willcox
Executive Summary
This study assesses the impact of exchange rate movements on the South African trade
balance. In particular, it analyses whether a depreciation of the currency can improve the
trade balance through promoting export production and import substitution? This
relationship is of central importance to the GA! macroeconomic strategy, which aims to
improve export growth through maintaining a stable and competitive real effective exchange
rate.
The study follows much international empirical research and uses the elasticity approach to
analyse the responsiveness of exports and imports to exchange rate movements. The study
draws upon the "ic#erdi#e$!obinson$%et&ler '"!%( condition which defines a set of
necessary conditions on the si&e of import demand, import supply, export demand and
export supply elasticities for a depreciation to improve the trade balance. "ecause of
limitations with this approach, additional relationships, such as the feedbac# of a
depreciation into domestic inflation, are also incorporated into the analysis.
Export and import performance
The study finds that export and imports remained relatively stable during the )*+,s and
early )*-,s, but grew strongly from the mid$)*-,s. xport growth was particularly strong
within manufacturing which has become the dominant source of export revenue, accounting
for ./ 0 of total exports 'excluding services( in 1,,,. Indicators of openness 'exports and
imports as a share of G23, import penetration and export orientation( have also risen
sharply, reflecting the rising importance of international trade for the domestic economy.
4or example, manufacturing exports as a share of output grew from ),.1 0 in )*-5 to 1+.5
0 in 1,,,. Similar strong growth in imports raised import penetration 'imports as a share of
consumption( from )- 0 in )**, to 61 0 in 1,,,.
The manufacturing trade balance has also improved during this period. In contrast, the
merchandise trade balance worsened which largely reflects the decline in gold exports. The
improvement in the manufacturing trade balance since the mid$)*-,s coincides with a
depreciation of the domestic currency. Although the exchange rate depreciation may have
contributed towards this improvement, numerous other policy changes ma#e it difficult to
identify the relative importance of the depreciation. 4or example, the Generalised xport
Incentive Scheme 'GIS( raised export production through subsidies. Trade liberalisation,
which accelerated from )**/, has substantially improved the profitability of export
production by reducing the cost of domestic and imported intermediate goods used in the
production process. 4inally, the ending of sanctions and the re$integration of South Africa
into the international mar#et have further enhanced export performance.
)
Theoretical considerations
Theoretically, an exchange rate depreciation has an ambiguous impact on the trade balance.
7n the import side, a depreciation raises the domestic price of imported products.
8onsumers and producers respond by substituting domestic for imported goods. 9owever,
the extent to which this substitution is possible is dependent on the availability of similar
domestically produced importing$competing products as well as the time period subse:uent
to the depreciation. %any developing economies are highly dependent on imported
intermediate 'such as oil or li:uid fuel( and capital goods used in the production process.
These economies lac# a wide range of substitutes for these imported products implying a
highly inelastic import demand function. ven if substitutes are available, ;lags in
recognition of the changed situation, in the decision to change real variables, in delivery
time, in the replacement of inventories and materials, and in production< give rise to an
inelastic demand curve in the short run '%agee, )*+6= 6,+(. In these cases a depreciation
raises the domestic currency value of imports, that may persist even in the long run.
9owever, the maximum increase in the domestic currency value of imports, which occurs
when import demand is perfectly inelastic, is the depreciation rate.
7n the export side, a depreciation raises the home price and>or lowers the foreign currency
price of domestic exports. The extent to which the depreciation is passed on to foreign
consumers in the form of lower foreign currency prices of exports 'their imports( depends
on the elasticities of export supply and demand. In a small country model, export firms are
price ta#ers in the international mar#et 'they face an infinite demand for exports( and the
domestic currency price of exports rise by the full depreciation. The response in exports to
the depreciation depends on the elasticity of supply= the greater the elasticity, the greater the
rise in exports. In all cases, however, the domestic currency value of exports rises by at least
the depreciation rate. Thus, in small countries a depreciation improves the trade balance.
In contrast, in an economy with excess capacity in the export sector, the depreciation is fully
passed$through to foreign consumers, i.e. the !and price of exports remain constant, but the
foreign currency price of South African exports fall by the full depreciation. In this case, the
response in exports depends on the elasticity of export demand. If export demand is highly
inelastic, export volumes, and thus the domestic currency value of exports, only rise by a
small amount. This leads to the well$#nown %arshall$?erner condition which states that if
both supply curves are perfectly elastic and the trade balance is &ero, a devaluation of the
exchange rate worsens the trade balance if the sum of the demand elasticities is less than
one. This condition is more li#ely to be satisfied in the short run when import and export
demand curves are inelastic. Thus a depreciation may initially worsen the trade balance
prior to its improvement in the long run. This is #nown as the @$curve effect.
South African exports and imports account for approximately ,.1- 0 and ,./- 0 of world
trade, respectively 'dwards and Schoer, 1,,1(. In the long run, the most appropriate model
for the analysis in South Africa is thus li#ely to be the small country model in which a
depreciation improves the trade balance. 9owever, the short$run dynamics may differ
substantially. As shown in the %arshall$?erner relationship, inelastic import and export
demand curves, combined with elastic export supply responses, may result in an initial trade
deficit in the short run. In modelling the impact of the depreciation on the trade balance, it is
important to capture these short$run dynamics. "ecause of the importance of the small
country assumption in determining the impact of a depreciation on the trade balance, this
study analyses the pricing behaviour of South African exporters. The assumption that South
1
Africa is a price$ta#er in the import mar#et is less contentious and is widely assumed in
international empirical research 'Goldstein and Aahn, )*-5(.
Pricing behaviour of South African exporters
This study finds that South African exporters are price$ta#ers in the international mar#et, at
least during the )**,s. As a result, export prices rise by the full depreciation of the currency.
This is clearly shown in the calculated real effective exchange rates in 4igure A where
South African export prices are compared to a range of developed and developing country
export 'rerxuv(, consumer 'rercpi( and producer 'rerppi( prices, all measured in a common
currency.
)

Figure A: Real effective exchange rates using various price indices, uarterly data
As found in other studies 'see Golub, 1,,,(, the !! remained constant or rose during the
late )*+,s, but fell as the currency depreciated during the )*-,s. 3articularly large declines
occurred in )*-5 as a result of the nominal depreciation following the !ubicon speech and
the debt crisis. The decline, however, is greatest when comparing South African export
prices to foreign consumer prices. South African export prices appeared to follow foreign
export prices relatively closely. Thus, the average price of South African exports relative to
foreign export prices did not improve substantially during the )*+,s or early )*-,s. This is
consistent with a small country in which domestic export prices are set according to the
world mar#et. Similar trends are evident during the )**,s. !! calculated using foreign
83I show a continued decline during the )**,s. In comparison, the !! calculated using
foreign 33I or export unit values has not shown a substantial decline since )**/, despite the
depreciation of the currency. This arises because export prices rise by the full depreciation
rate.
This relationship is confirmed using econometric techni:ues. The domestic currency price
of South African exports closely follows the exchange rate, rising rapidly in response to a
depreciation. The estimated long$run elasticity of domestic$currency prices with respect to
)
The !! is a weighted average of the real exchange rate, Px/eP* where Px is South African export prices,
e is the !and>foreign currency exchange rate and P* is the foreign price index.
6

Log real effective exchange rates (1995=log(100))
4.00
4.20
4.40
4.60
4.80
5.00
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5.40
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rerppi rercpi rerxuv
the exchange rate ranges between ,.+ to ,.*. This implies that a ) 0 depreciation of the
currency raises export prices by between ,.+ 0 and ,.* 0. The close association between
export unit values and the exchange rate is consistent with the small$country model where
the pass$through to foreign prices is &ero.
The implication is that export growth in South Africa is driven by changes in the
profitability of export supply, rather than price competitiveness vis$B$vis foreign producers.
In other words, export growth in South Africa is not constrained by insufficient foreign
demand, but rather by insufficient export supply.
The small country behaviour of South African exporters suggests that a depreciation
improves the trade balance. 9owever, this study also finds that the improved profitability of
export production through a depreciation is fre:uently eroded by domestic inflation and
wage increases. 4or example, no long$run deviation between the exchange rate, export
prices and domestic prices is found. As a result, no sustained relationship between exchange
rate movements and the trade balance is found when using graphical analysis. 4or a
comprehensive analysis of the impact of the exchange rate on the trade balance, it is thus
imperative that feedbac# between the exchange rate and domestic prices is explicitly
accounted for.
Econometric analysis
xport supply and import demand functions are estimated for South African manufacturing
and merchandise 'excluding gold( trade. To estimate these elasticities, the @ohansen
%aximum ?i#elihood procedure for multivariate cointegration analysis is used '@ohansen,
)*--, )**1(.
The econometric estimates of the export and import functions suggest that a depreciation
improves the trade balance. The long$run export supply elasticities range between $).,5 and
$).)1 are similar for manufacturing and merchandise goods 'excluding gold(. 9olding all
other variables constant, this implies that a depreciation raises exports by ).,5 to ).)1 0 in
the long run. The long$run import demand elasticities range between $).5* and $1./6, which
also show that a depreciation, holding other variables constant, reduce imports substantially.
These import demand elasticities exceed those of other South African studies that range
between C,.-5 and C).)5 'Aahn, )*-+, Smal, )**. and SenhadDi, )**+(.
Given the estimated elasticities, the elasticity of the trade balance 'normalised by the value
of imports( with respect to a currency depreciation 'E
!
( can be calculated. The appropriate
"ic#erdi#e$!obinson$%et&ler '"!%( condition for a depreciation to improve the trade
balance in a small country is given by
1
, > "# $% ! E E E .
Substituting the long$run export supply elasticity 'E
$%
E ).)16( and the import demand
elasticity 'E
"#
E $).5*( for merchandise goods into this relationship gives a long$run
exchange rate elasticity of the trade balance e:ual to 1.+)6. This implies that a ) 0
depreciation improves the trade balance of non$gold merchandise goods by 1.+)6 0 of the
value of imports in the long run. The elasticity for manufacturing is similar at 1.*-6.
9owever, the impact estimated using the "ic#erdi#e$!obinson$%et&ler condition
exaggerates the impact of a depreciation on the trade balance as it does not ta#e into account
1
Fote that the balanced trade assumption is imposed on this condition.
/
the feedbac# into domestic prices, nor the dynamics surrounding the convergence to
e:uilibrium. An advantage of the @ohansen procedure used in this study, is that it allows for
the endogeneity of all variables included in the regressions. The regression results indicate
that both domestic and export prices are strongly influenced by changes in the exchange
rate. A ), 0 depreciation raises export prices and domestic prices by *.1 0 and -.). 0 in
the long run, respectively. The rise in inflation thus negates some of the improved
profitability of export production arising from a depreciation of the currency. Gage costs
are also shown to increase with a depreciation further reducing the relative profitability of
export production.
The interaction between the exchange rate, domestic prices, export price and export supply
are more clearly shown in the generalised impulse responses presented in 4igure ". The first
figure shows the response in export volumes 'HI7?(, export prices '3H(, domestic prices
'33I27%( and unit labour costs 'J?8( to a one standard error depreciation of the exchange
rate '!AT(. The second figure displays the response in import volumes '%I7?( gross
domestic expenditure 'G2%AT3(, domestic prices '33I27%( to a one standard error
shoc# in import prices '3I%3JI(. In each figure the data on the hori&ontal axis represent
:uarterly periods.
Figure !: "eneralised impulse responses for merchandise exports #excluding gold$ and
imports
As shown in the first figure, there is a positive impact effect 'concurrent period effect( of a
depreciation on export prices and export supply. The immediate impact on domestic prices
and unit labour costs is close to &ero, but as the depreciation feeds into the system, wages
and domestic prices rise, reaching their pea# at around + :uarters. The exchange rate also
5
enerali!ed "#pulse $esponse(s) to one S%E% shoc& in the e'uation for E$A(E
XVOL
PX
ERAE
PP!"OM
#L$
%&ri'&(
-0.005
0.000
0.005
0.010
0.015
0.020
0.025
0.030
0 5 10 15 20 25 30
enerali!ed "#pulse $esponse(s) to one S%E% shoc& in the e'uation for )"*)+,
MVOL
)"EM*P
PP!"OM
P!MP#V
%&ri'&(
-0.01
-0.02
-0.03
-0.04
0.00
0.01
0.02
0.03
0.04
0 5 10 15 20 25 30
appreciates slightly from its initial shoc# and reverses the rise in export prices experienced
during the first / periods. xports rise sharply in the first period subse:uent to the exchange
rate depreciation, but decline rapidly relative to the initial shoc# in the subse:uent periods as
domestic price and wage increases erode export profitability. xports stabilise after
approximately + :uarters at a higher level than prior to the depreciation. 9owever, the new
level of exports is lower than it would have been if wages and domestic prices had not also
risen in response to the depreciation.
The dynamic process outlined in the second figure captures the impact of a shoc# in import
prices on the various variables. It does not directly capture the impact of a depreciation on
these variables. Fevertheless, in a small country a depreciation raises the domestic currency
price of import by the full depreciation rate. The figure is thus an indirect representation of
the impact of a depreciation on imports.
The concurrent effect a rise in import prices is a decline in import demand. In the
subse:uent period imports rise sharply, possibly in response to hoarding behaviour of
importers in the face of a currency depreciation. Imports only fall sharply in period /.
Import prices also feed into domestic prices, but slowly. Gross domestic expenditure
declines slightly as rising import prices negatively affect expenditure, production and
investment.
Together these relationships confirm that a depreciation can improve the trade balance, but
at the cost of increased inflation.
Policy conclusions
Several policy conclusions emerge from this study.
South African exporters are price%ta&ers in the international mar&et. As a
conse:uence, export growth is driven by the profitability of export supply, rather than price$
competitiveness vis$B$vis foreign producers. This does not imply that foreign prices are
unimportant. 4oreign price increases raise the profitability of export production and thereby
induce increases in the :uantity of exports supplied. A further implication, and of direct
relevance to this study, is that export prices rise :uic#ly in response to a depreciation rate
and rise by the full depreciation rate.
'nflation and (age gro(th undermine the positive impact of exchange rate
depreciation on the trade balance. A depreciation improves the trade balance by raising
the profitability of export supply and raising the cost of imports relative to domestically
produced products. 9owever, this is only sustainable if domestic price and wage increases
do not offset the relative price shifts that lead to increased export supply and demand for
import$competing products. If wages and domestic prices rise, as historical evidence
suggests it does, further depreciation of the currency will be re:uired to maintain the
improvement in the trade balance. This may lead to an inflation spiral.
A more important policy obDective is to reduce the volatility of the exchange rate.
"ecause South African exporters are price$ta#ers, exchange rate volatility translates directly
into profit volatility. This volatility is also shown in 4igure 8 which displays the price of
exports and domestic goods relative to unit labour costs. !ising ratios are a proxy for
improved profitability. As shown in the figure, profitability of export production is more
.
volatile than production for the domestic mar#et and is largely a result of exchange rate
movements.
Iolatility of profits increases the ris# associated with export production, particularly for
small businesses that do not have sufficient finances to hedge themselves against this ris#.
Jsing a national firm survey of South African manufacturing firms, dwards '1,,1( finds
that only 1- 0 of small firms export compared to +, 0 of large firms. Similar values are
found by 8handra et al. '1,,)( for the Greater @ohannesburg %etropolitan Area. The
entrance of small firms into the export mar#et is an important obDective to increase South
African export growth. Stable profits enabled by a stable currency may encourage entrance
of small firms into the export mar#et.
Figure ): Relative profitability indices
Fotes= 33I is the producer price index for South African output for domestic consumption. Jnit labour cost is
obtained from the !eserve "an# Kuarterly "ulletin.
Price and (age rigidity exacerbate the negative impact of an appreciation on export
supply. The impact of a depreciation and appreciation are not necessarily symmetrical and
are influenced by institutional structures that induce rigidities into the adDustment of wages
and domestic prices. 4or example, if wage and domestic price rise :uic#ly in response to a
depreciation, the gains to the trade balance will be short lived. In contrast, if wages and
prices are rigid downwards, an appreciation of the currency may lead to a sustained deficit
in the trade balance. 8urrent trends in domestic inflation suggest that prices have been slow
to adDust downwards in response to the appreciation of the currency from mid$1,,1. South
African exporters have thus faced falling export prices 'in !ands( combined with continued
increases in their costs of production. These trends compound one another leading to
significant reductions in export production. The sharp appreciation of the currency in 1,,1
and 1,,6 will thus have a severe negative impact on the trade balance.
)an a depreciation offset high domestic production costs, including labour costs, that
inhibit export gro(th* dwards and Golub '1,,1( show that a depreciation positively
boosts exports by reducing South African wages relative to other country wages measured
+

$elative profitabilit- index (1995=1)
0.6
0.8
1
1.2
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1.8
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Merc+a(,i-e Px.u(i/ 0a1&ur c&-/ PP!.u(i/ 0a1&ur c&-/
in a common currency. 9owever, improving labour cost competitiveness through
depreciation is not sustainable in the long run. 2epreciation of the currency reduces the real
wage of wor#ers, who then bargain for compensatory wage increases. dwards and Golub
'1,,1( show that the depreciation of the South African !and vis$B$vis other developing
country currencies during the )**,s failed to offset wage increases in many industrial
sectors, and in particular labour$intensive sectors.
Alternative approaches towards increasing export performance and competitiveness of
import competing firms need to be found. 3rofitability of export production can be
improved through enhanced productivity gro(th combined (ith (age moderation.
dwards and Golub '1,,1( show that both wages and productivity are important
determinants of export growth. This study also finds that high unit labour costs, arising from
low labour productivity and>or high wages, negatively affect export supply. 3olicy that
encourages productivity improvements combined with wage moderation will thus enhance
export growth.
There are a number of approaches to improving productivity growth. 4irstly, improvements
in education, particularly the :uality thereof, are essential long$run policy obDectives
necessary to raise the productivity of South AfricaLs labour force. In addition to enabling
real wage increase, productivity improvements will enhance South AfricaLs export
performance.
Increased investment in ne( technology and productive capacity is a further avenue
through which to improve labour productivity. Increased investment in new technology can
be encouraged through an accelerated program of tariff liberalisation. This lowers the
cost of access to foreign technology as well as induces productivity gains through increased
international competition. Gor# by @onsson and Subramanian '1,,,( has shown a positive
relationship between improved T43 growth and trade liberalisation. Ian Seventer '1,,)(
also notes that the reduction in tariff rates has substantially reduced the anti$export bias
arising from protection on intermediate goods used in the production process. ?ower
production costs and improved productivity will also increase entry of firms into the export
mar#et, and thus further enhance the diversification of exports shown by "lac# and Aahn
')**-(. Although it is feared that tariff liberalisation will negatively affect employment,
dwards '1,,)a( shows that employment creation through improved export growth
compensates for employment lost in import competing sectors.
-
Exchange rate depreciation and the trade balance in
South Africa
Lawrence Edwards and Owen Willcox
+, 'ntroduction
Since the early )*-,s South AfricaLs trade policy regime has shifted from one of import
substitution towards one of export orientation. This shift has been encouraged by trade
liberalisation, which accelerated in )**/ with tariff liberalisation, and the GA!
macroeconomic strategy that was explicitly expected to transform South Africa into a
;competitive, outward orientated economy< 'GA!, )**.(. An exchange rate policy to
#eep the real effective exchange rate stable at a competitive level formed a #ey part of the
GA! strategy. Implicit in this view is that lower real effective exchange rates enhance
international competitiveness and thus improve export performance.
2uring the late$)**,s the real effective exchange rate has shown a downward trend 'Golub,
1,,,(, but has been characterised by much volatility. At the same time export growth has
improved and there is consensus that the decline in the real effective exchange rate has
much to do with this. ?ess focus has been placed on the impact of the exchange rate on
imports. South African imports are highly capital intensive suggesting that the depreciation
of the currency will not necessarily reduce import volumes by a significant :uantity. The
domestic currency value of imports may rise with a depreciation offsetting the positive
impact that improved export growth has on the trade balance. Intermediate goods also
account for a high proportion of total South African imports. If domestic substitutes are
unavailable the responsiveness of import demand to a depreciation will further diminish.
%ore importantly, a depreciation raises the cost of imported intermediate inputs and thus the
price of domestic products. These cost increases can offset some of the gains in
competitiveness of both export and import$competing products achieved through a
depreciation of the currency. The feedbac# of the depreciation into domestic prices is thus
an important element in the adDustment process of the trade balance.
The importance of exchange rate movements on the economy has to come to fore during the
previous two years. The large depreciation in the currency towards the end of 1,,)
improved export competitiveness, but raised the cost of imported products and domestic
inflation. 2uring 1,,1 the currency appreciated, negating much of the improved
competitiveness. The overall impact of exchange rate movements such as these on the trade
balance is not clear. This study analyses the relationship between exchange rate movements
and the trade balance in more detail.
This paper is structured as follows. Section 1 discusses the economic theory guiding the
empirical analysis followed within this study. The impact of the exchange rate on the trade
balance is shown to be dependent on the elasticities of demand and supply within the export
and import mar#ets. Section 6 then presents an overview of the empirical methodologies
used in the international literature. Section / presents an overview of South African
empirical research on the impact of exchange rate changes on the trade balance as well as
the estimated trade elasticities. This is followed by a graphical analysis of South African
exports, imports and relative price trends in Section 5. The results of the econometric
*
estimates are presented in Section .. Section + briefly interprets the results and provides
some policy conclusions.
-, Theory
2.1 Introduction
Three approaches have been used to analyse the impact of exchange rate movements on the
trade balance= 'a( Aeynsian absorption approach, 'b( monetary approach and 'c( the
elasticity approach.
The Aeynesian based absorption approach and the monetary approach focus on the
macroeconomic lin#ages and identities, rather than the microeconomic relationships of the
elasticity approach. In the absorption approach, the national income accounting identity is
maintained, i.e.
6
'H$%( E M $ '8NING(.
This implies that the trade account can only improve if domestic output growth exceeds
domestic absorption '2unn and %utti, 1,,,= /6,(. A devaluation improves the trade balance
if the substitution towards domestic goods in response to the relative price shift boosts
output more than absorption. This is more li#ely in an economy characterised by excess
capacity where the Aeynesian multiplier effect wor#s. In an economy near full employment,
or one facing severe bottlenec#s in production, output is unli#ely to increase and the trade
balance can only improve if absorption declines. Inflationary pressures also undermine the
relative price shifts that induce an increase in export production and a decline in
consumption of imported goods.
In the monetarist approach, a balance of payments deficit is entirely a monetary
phenomenon caused by excessively expansionary monetary policy '2unn and %utt, 1,,,(.
A devaluation only has an effect on the balance of payments through its impact on the real
money supply. Thus, a devaluation improves the balance of payment by raising domestic
prices and thereby reducing the real money supply. 2evaluations fail if they are followed by
further increases in the nominal money supply that re$establish the original dise:uilibrium.
The long$run effect on the trade balance is thus ambiguous.
The elasticity approach is the most common approach used to assess the impact of
exchange rate changes on the current account. In this approach, the impact on the trade
balance is determined by the response of exports and imports to changes in prices arising
from movements in the exchange rate. The reaction in these mar#ets is thus a function of the
elasticities of supply and demand. As this is the approach followed in this study, the
following section analyses the elasticity approach in more detail.
2.2 The elasticities approach
Analysis using the elasticity approach is largely based on variants of the "ic#erdi#e$
!obinson$%et&ler '"!%( condition, and in particular the simplified %arshall$?erner '%?(
version of this condition. The "!% condition defines a set of necessary conditions on the
si&e of import demand, import supply, export demand and export supply elasticities that will
result in an improvement in the countryLs balance of trade. A devaluation changes the
6
This is obtained from the first difference of H C % E M C '8NING(
),
relative prices of imports and exports in a way that encourages export growth and reduces
import volumes. 9owever, these shifts do not necessarily improve the trade balance.
The effect of a devaluation on the balance of trade '&(, in domestic currency, depends on
how the value of exports 'P
x
%( and imports 'P
m
#( respond to this devaluation. This can be
represented as
E .:
e
# P
e
% P
e
&
d
m
s
x

( ' ( '
where reflects OchangeL, e is exchange rate, P
x
is the price of exports, % is the :uantity of
exports produced and sold, P
m
is the price of imports and # is the consumption of imports.
8hanges in the value of exports or imports depend on how export and import prices change
and the effect this has on the volume of exports and imports. "oth the price and output
responses of exports and imports in turn depend on domestic and foreign price elasticities of
supply and demand for export and import products. Jsing simple algebraic manipulations a
general formula for the elasticity of response of the current account balance to the exchange
rate 'E
ca
( can be derived. This formula 'drawn from Iane# ')*.1(( is represented as
E .:
) ( > '
)
) ( > '
)

,
_

"# $#
$#
$% "%
"%
#
%
!
E E
E
E E
E
'
'
E

where E
!
is the exchange rate elasticity of the trade balance 'normalised by the value of
imports(
/
, '
%
and '
#
are the values of exports and imports, respectively, E
"%
and E
$%
are the
export elasticities of demand and supply, respectively, and E
$#
and E
"#
are the import
elasticities of supply and demand respectively. In this formula, the exchange rate elasticity
of the trade balance 'E
!
( is measured in foreign currency terms. 9owever, if trade is
balanced ''
%
E '
#
( the conditions for improving the trade balance expressed in terms of
domestic of foreign currency are e:uivalent '?indert and Aindleberger, )*-1(. This
assumption will be imposed in the remainder of the theoretical analysis. In the discussion
that follows, changes in the trade balance will be referred to in !and terms.
Gor#ing within the elasticity approach, there are four important variations that will
determine the current account response. The $mall ountry and the Prices (ixed in $eller)s
urrency cases are of direct relevance to the debate in South Africa and are briefly
discussed. The remaining two cases are presented in "ox ) and "ox 1.
ase *+ $mall country case
In the first case, the economy is modelled as a small price$ta#er in which export and import
prices are set in the international mar#et. The export demand '2
H
( and supply 'S
H
( curves
are shown in the left$hand side diagram of 4igure ), while the import demand '2
%
( and
supply 'S
%
( curves are shown in the right$hand side diagram. All prices are measured in
local currency.
"ecause of the small price$ta#er assumption, the demand curve for exports is perfectly
elastic 'E
"%
$(, indicating that the overseas mar#et can absorb any amount of output that
the small country can produce without affecting the world price. 7n the supply side, the
/
E! E 'd,&/'#-/.dr/r( where ,& is the trade balance.
))
supply of imports is perfectly elastic 'E
$#
( meaning that changes in local demand do
not influence international prices.
Substituting the demand and supply elasticities into : ,, the "!% condition for an
improvement in the trade balance becomes=
E .:
, > "# $%
#
%
! E E
'
'
E
,
This condition is satisfied so long as the import demand curve is downward sloping and the
export supply curve is upward sloping. A depreciation is thus expected to improve the trade
balance in a small price$ta#ing economy.
Figure +: Small country case

3 H
Imports xports
2 H
S H
S %L
2 % 3 %
S %
2 HL
This result can be explained using 4igure ). A devaluation shifts the demand curve for
exports upwards to 2
H
L
and the supply of imports curve upwards to S
%
L
. This is because
export and import prices measured in domestic currency rise by the full depreciation rate. In
response to the price changes, the :uantity of exports supplied increases and the :uantity of
imports demanded decreases. The value of exports increases by a greater percentage than
the depreciation as both the volume and price of exports rise. The volume of imports
declines, but this does not imply that the value of imports measured in domestic currency
declines. This depends on the elasticity of import demand. If import demand is elastic, the
domestic currency value of imports falls and the trade balance improves. If import demand
is inelastic, the domestic currency value of imports rises. 9owever, the trade balance still
improves, as the maximum the value of imports can rise by is the devaluation rate 'occurs
when import demand is perfectly inelastic(. The domestic currency value of exports,
however, increases by more than the depreciation rate.
The si&e of the impact of a devaluation depends on the elasticities of export supply and
import demand. The more elastic export supply and import demand, the greater the
improvement in the trade balance.
)1
ase /+ Prices fixed in seller)s currency
The second case reflects the well$#nown %arshall$?erner condition where a depreciation
has an ambiguous impact on the trade balance. In this case it is assumed that prices are set in
the sellerLs currency. This is an accurate representation on the import side for a small
country, as one would expect world prices to be set in foreign currencies 'E
$#
(. 7n the
export side, however, this assumption implies a perfectly elastic supply curve for exports
'E
$%
(. This condition is only li#ely to be satisfied if excess capacity exists in the
domestic economy
5
.
5
This case may be an accurate representation of the late )*-,Ls when local demand was significantly below
output, meaning that producers had spare capacity and used export mar#ets to vent this surplus capacity.
)6
!ox +
ase 0+ 1nelastic demands
The third case is shown in 4igure 1 below. 7n the left is the mar#et for exports and the right$hand
diagram illustrates the mar#et for imports. All prices are measured in local currency. In both cases
demand is perfectly inelastic 'i.e. E"% E E"# E ,( and the :uantity demanded does not respond to price
changes.
Figure -: 'nelastic demands
3
H
Imports xports
2
H
S
H
S
%L
2
%
3
%
S
%
Substituting the inelastic demands '2H E 2% E ,( into the "!% e:uation reduces the formula to=
E .: . , > < # % ! ' ' E
As this condition implies, a devaluation in the case of inelastic demands une:uivocally worsens the trade
balance. This can be shown using the diagrams in 4igure 1.
In the case of exports, a devaluation will lead to an upward shift of the demand for exports curve. In
4igure 6 above, this shift cannot be seen as the new curve is superimposed on the old curve. The vertical
distance between similar points on the two demand curves is e:ual to the percentage value of the
depreciation. 7n the import side, the depreciation will lead to an upward shift of the supply from S% to
S%L .
The domestic price and :uantity of exports stay exactly the same leaving total export revenue measured
in domestic currency unchanged. The devaluation is fully passed$through into imported prices valued in
domestic currency. Import :uantities, however, do not change as import demand is perfectly inelastic. As
a conse:uence the domestic currency value of imports rises by the same rate as the devaluation and the
trade balance moves into deficit.
Figure /: Prices fixed in seller0s currency

3 H
Imports xports
2 H
S H
S %L
2 %
3 %
S %
2 HL
Substituting the supply elasticities into : ,, the "!% condition becomes=
E .:
, ( ) ' > < "# "%
#
%
! E E
'
'
E
A devaluation can either improve or worsen the trade balance and is dependent on the
import and export demand elasticities. Assuming balanced trade, this condition can be re$
written as the well$#nown %arshall$?erner condition
E .:
) > +
"# "%
E E
,
which states that if both supply curves are perfectly elastic and the trade balance is &ero, a
devaluation of the exchange rate will improve the trade balance if the sum of the demand
elasticities is greater than one.
A devaluation shifts the demand curve for exports upwards from 2
H
to 2
H
L. The domestic
currency price does not change, implying that the pass$through of an exchange rate
depreciation to the foreign currency price of the home country exports is complete. In other
words, a ), 0 depreciation lowers the foreign currency price of home country exports by ),
0. The :uantity of export demanded rises in response to lower prices, but the si&e of the
increase depends on the elasticity of export demand 'E
"%
(. If export demand is highly
inelastic, export volumes only increase by a small amount, as does the domestic currency
value of exports. This can be shown by a very steep "x curve and a small shift to the right in
response to a devaluation.
7n the import side, domestic prices rise by the full depreciation rate. Import volumes
decline, but the change in the domestic currency value of imports depends on the elasticity
of import demand. If import demand is inelastic, the value of imports increases. Similarly, if
import demand is elastic, the domestic currency value of imports declines. A combination of
a low elasticity of export demand and a low elasticity of import demand can result in a
worsening of the trade balance in response to a devaluation. The more elastic the export and
import demand curves, the greater the improvement in the trade balance in response to a
devaluation.
)/
2.3 The J-curve
The above four scenarios present extreme views regarding the elasticities of demand and
supply in order to define the parameters of the relationship between changes in the exchange
rate and the trade balance. In reality, the demand and supply of exports and imports are
unli#ely to be perfectly elastic or inelastic. The demand and supply elasticities are a function
of a number of variables such as the si&e of the domestic economy, the availability and
number of substitutes in production and consumption, the returns to scale in production, the
availability of spare capacity and resources, etc.
The elasticity of demand and supply also differ in the short and long run, with the long$run
elasticities generally exceeding the short$run elasticities. Ghile the long$run impact of a
devaluation on the trade balance may be ade:uately reflected in the cases above, the short$
run dynamics of the trade balance as it moves towards this e:uilibrium may differ
substantially.
)5
!ox -
ase 2+ Price fixed in buyer)s currency
The final case is more of a theoretical exercise and is one in which prices are set in the buyerLs currency.
xport mar#ets face a world price set in terms of the foreign currency, while imports are priced in the local
currency. Jnder these assumptions the demand curves in both mar#ets are perfectly elastic 'E"% $ and
E"m $(, as shown in . Substituting these demand elasticities into : ,, the "!% condition for an
improvement in the trade balance becomes=
E .: ,
, )> + + Esm Esx
'm
'x
Eca
3rovided supply elasticities are not negative 'a sufficient but not necessary condition(, the trade balance will
improve in response to a devaluation.
Figure 1: Price fixed in buyer0s currency
3H
Imports xports
2H
SH
S%L
2%
3%
S%
2HL
2ifferences between the long and short$run elasticities lie behind the hypothesised @$curve
effect of a devaluation. As shown in case 1 and 6, a devaluation is more li#ely to worsen the
trade balance in countries facing a combination of inelastic export and import demand
functions and elastic export supply curves. These demand conditions are more li#ely to
occur in the short run.
%any developing economies are highly dependent on imported intermediate 'such as oil or
li:uid fuel( and capital goods used in the production process. These economies also lac# a
wide range of substitutes for these imported products implying a highly inelastic import
demand function. ven if substitutes are available, ;lags in recognition of the changed
situation, in the decision to change real variables, in delivery time, in the replacement of
inventories and materials, and in production< give rise to an inelastic demand curve in the
short run '%agee, )*+6= 6,+(. In these cases a devaluation raises the domestic currency
value of imports in the short run.
7n the export side, two factors delay the positive impact on the trade balance from a
devaluation=
). 4irstly, the rise in the export price in domestic currency terms in response to a
devaluation may be slow. 4or example, in the very short term, the domestic currency
price of goods that have already been purchased or that are in transit when the
depreciation occurs will not necessarily rise.
1. Secondly, export volumes may respond slowly to the devaluation in the short run.
As a result, a depreciation may not boost the value of exports in the short run. Together, low
elasticities of export and import demand in the short run can worsen the trade balance in
response to a devaluation. In the long run, as these curves become more elastic, the trade
balance improves.
2.4 Extensions/limitations of the elasticity approach
The elasticities approach provides a highly simplified, yet useful, framewor# for analysing
the impact of exchange rate changes on the trade balance. 4or a comprehensive analysis,
however, it is desirable to ta#e into account other factors not directly dealt with in the
elasticity approach. Some of these limitations are discussed as they feed into the empirical
analysis conducted later in this paper.
The elasticity approach is a partial euilibrium approach and does not ta#e into account
the macroeconomic effects arising from changes in prices and production in response to a
devaluation. As discussed in the absorption and monetarist approach, a depreciation gives
rise to macroeconomic effects that fre:uently undermine the positive impact of an exchange
rate devaluation on the trade balance.
7f particular importance, is the inflation impact of a devaluation. A devaluation raises the
price of imported goods utilised in the production process and also results in a substitution
in the consumption of domestic goods for imported products. "oth these demand and supply
effects place upward pressure on domestic prices. The si&e of the effect depends on the
substitutability of domestic goods for imported and exported goods 'in both consumption
and production(, the share of imports in total income, the elasticity of prices with respect to
input prices and the elasticity of factor prices with regard to domestic price levels. The
).
larger each of these factors is, the larger the response of domestic prices will be to the
increase in import prices 'Goldstein P Ahan, )*-5(. Institutional structures, such as wage
index schemes, tend to raise the sensitivity of domestic prices to import price increases
'Sachs, )*-,, :uoted in Goldstein P Ahan, )*-5(.
!ising domestic prices have three effects=
). 4irstly, they undermine the substitution of domestic for imported products arising from
the devaluation.
1. Secondly, the foreign currency price of exports rise, which negatively affects
competitiveness and the :uantity of exports demanded.
6. Thirdly, rising domestic prices lower the profitability of export production and reduce
export supply.
All these effects reduce the positive impact of a devaluation on the trade balance. Artus P
%cGuir# ')*-)(, for example, find that high domestic price feedbac# reduces the trade
balance effect by /, 0.
A second consideration is the interdependence between export production and imported
intermediate goods. Iery often exports are produced using imported capital goods. South
Africa, for example, has a highly capital intensive structure of exports 'dwards, 1,,)b(.
Growth in exports thus raises demand for imports. At the same time, rising prices of imports
reduce export competitiveness. "ecause the elasticities approach does not ta#e this
interdependence into account, the implied positive impact on the trade balance arising from
a devaluation may be exaggerated.
4inally, the elasticity approach does not ta#e into account the numerous general
euilibrium interactions arising from currency movements, such as the responsiveness of
production and consumption to relative price shifts '2ornbusch, )*+5(. The approach also
does not explain how the excess of income over expenditure that corresponds to a trade
surplus arises, as is emphasised in the absorption approach. 4inally, production responses in
export and import$competing sectors are not lin#ed into real income and expenditure effects.
4or example, rising incomes raise import demand.
2. !iscussion
This section used a simple supply and demand framewor# to analyse the various possible
outcomes of a devaluation on a countryLs trade balance. The most appropriate model for the
analysis in South Africa is li#ely to be the small country model, at least in the long run.
South African exports and imports account for approximately ,.1- 0 and ,./- 0 of world
trade, respectively 'dwards and Schoer, 1,,1(. A depreciation is thus expected to improve
the trade balance in the long run. 9owever, the short$run dynamics may differ substantially.
As shown in the %arshall$?erner relationship, inelastic import and export demand curves,
combined with elastic export supply responses, may result in an initial trade deficit in the
short run. In modelling the impact of the depreciation on the trade balance, it is important to
capture these short$run dynamics.
A further consideration is the inclusion of some of the macroeconomic lin#ages that
moderate the variation in the trade balance in response to a depreciation. 7f particular
relevance to the South African debate, is the feedbac# of a depreciation onto domestic price
inflation. Inflation tends to negate some of the positive effects of a depreciation on the trade
balance. This study attempts to incorporate the inflationary impact of a depreciation in order
)+
to provide a more comprehensive assessment of currency movements on the trade balance
than is suggested by the simple elasticities approach.
The following section reviews international and domestic empirical literature dealing with
the relationship between changes in the currency and the trade balance.
/, Empirical methodology
There are various approaches followed in estimating the impact of a currency depreciation
on the trade balance. In the direct trade balance regressions, the trade balance is regressed
directly on exchange rates and other variables '%iles, )*+*Q "hamani$7s#ooee, )*-5, )*-*Q
9imarios, )*-5Q !ose, )**,Q Shirvani and Gilbratte, )**+Q !incRn, )**-Q Aale, 1,,)(.
Ghile this approach enables a direct estimate of the relationship between the trade balance
and the exchange rate, it lac#s theoretical structure. The coefficient on the exchange rate
variable is a weighted average of the various elasticities of demand and supply of both
imports and exports. It is thus not possible to determine whether the relationship is driven
by demand or supply features. The empirical results of these analyses are ambiguous and no
consensus on the impact of the exchange rate on the current account is evident.
The 2eynesian based absorption and monetary based studies include general e:uilibrium
and econometric models. The economy$wide structural general e3uilibrium models preserve
the #ey macroeconomic identities, particularly the national income accounting identity. 4or
example, Gylfason P !adet&#i ')**)( develop a general e:uilibrium model for a range of
developing economies and find that a ), 0 devaluation improves the current account by ).5
0 on average in the sample of )1 countries studied. These models, however, are highly
sensitive to the functional forms of the consumption and production functions, as well as the
elasticities and other parameters imposed on the model.
The econometric studies estimate functions derived from the absorption and monetary
approaches. 9ossain ')***( estimates an intertemporal model in which transitory shoc#s in
income affect the current account, but not permanent shoc#s. This is consistent with the
absorption approach where the trade balance e:uals the difference between income and
absorption. 9ossain ')***( finds results consistent with the intertermporal model for the
JS, but not for @apan. 9e also finds a long$run relation between the current account and the
real exchange rate for both countries. 7ther econometric studies, such as "ahmani$7s#ooee
')*-5( and !incRn ')**-(, include production and money supply variables into their set of
independent variables explaining the trade balance. 9owever, these are largely ad hoc
additions and do not capture to the essence of the macroeconomic lin#ages emphasised in
the absorption and monetary approaches. A consistent interpretation of their coefficients is
thus not possible.
A third set of studies, the pass%through studies, estimate the pass$through of exchange rate
changes into export price changes 'in foreign currency terms( and import price changes 'in
domestic currency terms( 'Swift, )**-Q 9anninen and Toppinen, )***Q %ahdavi, 1,,,(.
These studies generally find that import prices respond relatively :uic#ly to a devaluation,
but that export prices 'in domestic currency terms( respond more slowly 'Goldstein and
Aahn, )*-5= ),-*(. This suggests that import supply elasticities are infinite, but that the
short$run elasticities of demand are low, which can give rise to the @$curve effect. In the
medium term, however, empirical evidence suggests that export prices rise by the full
depreciation rate in small or natural resource abundant economies 'such as South Africa(
)-
'Goldstein and Aahn, )*-5= ),-*(. As shown in the small country case discussed in the
theory section, an exchange depreciation thus improves the trade balance in the long run.
4inally, in the elasticity based studies export and import elasticities are estimated directly.
In the following section, the empirical methodologies used in the elasticity approach are
analysed in more detail.
3.1 The elasticities approach
This approach involves the direct estimation of the demand and supply elasticities for
exports and imports. These elasticities are then substituted into : , to determine whether
the "!% condition for an improvement in the trade balance in response to a devaluation is
satisfied.
Export demand and supply functions
The standard export model, as discussed by Goldstein and Aahn ')*-5(, can be represented
as a system of e:uations for export supply '%
s
( and export demand '%
d
(. These functions are
represented as
.
E .: %
d
4
5
6
*
Px 6
/
erate6
0
P* 6
2
7* .
*
8 5,
/
9 5,
0
9 5,
2
9 5-
%
s
4
5
6
*
Px 6
/
P 6
0
lprod 6
2
w 6
:
tariff .
*
95,
/
85,
0
95,
2
85,
:
85-
%
s
4 %
d
where 7*, P*, P, 7S Px, lprod, w, erate and tariff are real foreign income, price of foreign
domestically produced goods, domestic price, foreign income, domestic price of exports,
labour productivity, wage rates, exchange rate and tariffs, respectively. Export demand is
positively affected by foreign income '7*( and the price of competing foreign goods 'P*(,
but is negatively affected by the foreign price of domestic exports 'Px*4 Px/erate(.
Formally it is assumed that the demand function is homogenous of degree &ero in prices and
the further restriction
*
'E $
/
( 6
0
E, can be imposed.
Export supply is positively affected by Px and lprod, but negatively affected by P, w and
tariff. 7ften domestic income is also used as an exogenous variable in the export supply
function. This traditionally has a positive sign, as increased production is a proxy for non$
price improvements in competitiveness arising from increased economic activity 'Goldstein
and Aahn, )*-5(. A capacity utilisation variable can also be included to model the Ovent$for$
surplusL hypothesis. The use of capacity utilisation has been used extensively in the SA
literature '4allon and 3ereira da Silva, )**/Q Tsi#ata, )***(. The former finds a negative
coefficient while the latter finds the coefficient to be insignificantly different from &ero.
The export supply and demand e:uations solve for the two endogenous variables, Px and %,
simultaneously. This has implications for the estimation procedures followed. %ost
international 'SpitTller, )*+-Q Gilson and Ta#acs, )*+*Q 9aynes and Stone, )*-1( and
domestic '4allon and 3ereira da Silva, )**/Q "horat, )**-Q Tsi#ata, )***Q Golub and
8eglows#i, 1,,)( empirical studies estimate single export and>or import e:uations. The
estimation of a single export e:uation is only appropriate in cases where either the elasticity
.
This model is an imperfect substitutes model where imperfect substitutability between domestic and export
products enables domestic and export prices to differ from one another 'Goldstein and Aahn, )*-5(.
)*
of supply or demand is infinite.
+
Ghen the elasticity of supply is infinite 'case 1 in the
theory section(, the appropriate function to estimate is the export demand e:uation.
3roblems of simultaneity do not arise as Px is fixed and is no longer endogenous. In the
small country case where export demand is infinitely elastic 'case )(, the export supply
curve is the appropriate function to estimate. Px is again fixed, but is determined by foreign
prices.
%ore importantly, if the elasticities of supply and demand are not infinite, then the
estimation of a single e:uation with both export volumes and export prices will suffer from
simultaneous e:uation bias. In the export demand e:uation, Px is endogenous and is
correlated with the error term. This tends to bias the price elasticity of demand coefficient
downwards 'Goldstein and Aahn, )*-5(. The solution is to estimate the export supply and
demand e:uations as a system. Although a reduced form e:uation can be estimated 'solve
for Px and % in terms of the exogenous variables(, the coefficients on the relative price
variable in the export demand function is neither the export demand nor the supply
elasticity. The coefficient is a weighted average of both.
The endogeneity problem is not confined to the Px and % variables in : ,. The system
assumes that the exchange rate, domestic prices and wages are exogenous. 9owever, as
shown in many of the pass$through studies discussed earlier, domestic prices and wages are
strongly influenced by the exchange rate and foreign prices. 4urther, significant increases in
exports can cause the currency to appreciate. Ideally, the estimation techni:ues should allow
for the endogeneity of these variables.
In their review of the literature Goldstein and Aahn ')*-5( find that the long$run export
price elasticities of demand range between C).15 to C1.5. SenhadDi and %ontenegro ')**-(
analyse export demand elasticities in 56 developed and developing countries and find an
average long$run demand elasticity of C). xport demand elasticities in Africa appear to be
lower and range between C,.,/ and C1.) 'Ari&e, )*-+(. xport supply elasticities in
developed economies range between ) to / 'Goldstein and Aahn, )*-5(, but appear to be
lower in Africa where they range between , and ,.** 'Ari&e, )*-+(.
1mport demand and supply functions
Import demand functions are generally estimated under the assumption of infinite world
supply. This is appropriate in a small country case li#e SA.
-
The relevant function is of the
form=
E .: #
d
E
5
6
*
Pm 6
/
Pdom 6
0
7 6
2
tariff .
*
8 5,
/
9 5,
0
9 5,
2
8 5-
where Pm, Pdom, 7 and tariff are the import price, domestic price, real gross domestic
expenditure and tariff rates, respectively. Import demand is positively affected by rising
domestic prices and real domestic expenditure, but is negatively affected by rising import
prices. Import prices 'Pm( can rise either through a depreciation of the exchange rate or a
rise in foreign prices. As in the demand e:uation, homogeneity of import demand implies
*
6
/
E,.
+
Some of these solve for the system to obtain reduced form e:uations. It is not, however, always possible to
extract the relevant elasticities from the estimated reduced form coefficients.
-
To test this assumption we regressed the import price on the exchange rate, foreign prices and deviations of
SA G23 from trend. Ge find that exchange rate depreciations are fully passed through to import prices
measured in domestic currency.
1,
stimated long$run import demand elasticities for developed economies generally range
between C,.5 to C).5 'Table /.) in Goldstein and Aahn, )*-5= ),+*(. The short$run
elasticities are roughly half the long$run elasticities and about 5, 0 of the adDustment occurs
within a year. !esults for developing countries are less available. Ari&e ')*-+( estimates
long$run import demand elasticities between C,..+ and C).+ for a number of African
economies. SenhadDi ')**+( estimates import demand elasticities for .. developed and
developing economies and finds that the short$run elasticity is close to &ero, but the mean
long$run elasticity is e:ual to C).,+.
Together these results suggest that "!% condition is satisfied and that a devaluation will
improve the trade balance. The only exception appears to be African countries where low
elasticities were estimated.
Econometric methodology
The analysis above has highlighted a number of important issues concerning the estimation
of the supply and demand elasticities.
4irstly, the export supply and demand functions simultaneously determine the export
prices and export volumes and hence need to be estimated as a simultaneous system of
e:uations.
Secondly, other variables such as the exchange rate, wages and domestic prices are not
necessarily exogenous. The estimation techni:ue needs to allow for the endogeneity of
these variables.
A further problem associated with the estimation of the supply and demand functions is that
the data are fre:uently non$stationary in levels. The estimation of these functions in levels
may thus give rise to spurious coefficients if no cointegrating 'long$run( relationship exists.
Jsing log difference growth rates solves for the problem of non$stationarity if variables are
integrated of order one '1.*-(. 9owever, the regression results then only provide information
on the short$run dynamics around a possible long$run relationship. The estimation
techni:ues thus need to explicitly deal with the non$stationarity of data.
An appropriate methodology in these circumstances is the @ohansen %aximum ?i#elihood
procedure for multivariate cointegration analysis '@ohansen, )*--, )**1(. This approach is
appropriate as it allows for the estimation of a system of e:uations in which all variables are
endogenous '@ohansen and @uselius, )**,(. In addition, the techni:ue enables the estimation
of the long$run relationships as well as the short$run dynamics surrounding the adDustment
process 'the error correction e:uations(. The methodology is discussed in more detail in the
Appendix.
1, South African empirical evidence
There is limited research on the impact of the devaluation on the trade balance in South
Africa, with only one study, Smal ')**.(, focussing on this relationship. Fumerous studies,
however, have estimated export demand elasticities. 4ewer studies have estimated export
supply and import demand elasticities. An overview of these studies can give insight into
whether the "!% conditions for an improvement in the trade balance are satisfied. Table )
provides a summary of the various estimated elasticities for export and imports in South
Africa.
1)
Table +: South African price, income and other export elasticities
Author Price elasticity of
demand
Price elasticity
of supply
'ncome Period )omments
Export functions
"ehar and dwards '1,,6( $6 to $. ,.+. to ).6 1 to 6.5 )*+5:) to 1,,,:/ %anufacturing. Jses
I8%
dwards and Golub '1,,1( $)..1 to C1.+. ).1- to 6.)* )*+,$)**+ %anufacturing. Jses
panel data techni:ues
Golub and 8eglows#i '1,,)(
)
,.+- to $).,- ,.+. to )./. )*+,$*- Jses alternative price
variables in !!s.
Golub '1,,,(
)
$,.+- to $).6+ ,..1 to )./1 )*+,$*- Jses alternative price
variables in !!s.
$,.** to C,.-/ FS to 6..1 )*+)$*- stimated in first
differences
Faude '1,,,( S stimated in first
differences
Tsi#ata ')***( $).,* in S!
C).. in ?!
,.55 in S!
,.-) in ?!.
)*+,$*. !educed form xport
function. Jses !!
$,.- ,./5 in S! stimated in first
differences
SenhadDi and %ontenegro ')**-( $,.5 ,..5 7bs E 6/ %ulti$country study
Smal ')**.( $,.5- 'merchandise(
$)./ 'manufacturing(
$,.6) 'minerals(
,.+. to ).,/ )*-5K) to )**/K/
4allon and 3ereira de Silva
')**/(
$,./6 in S!
$,..6 in ?!
,.,1 'only for
post -5(
)*+1$-* Jsed different variables
for relative price.
"horat ')**-( 1.** for 3aper
P paper prods
).,) for 4ood,
beverage,
tobacco
Kuarterly data=
)**,.,1 C*5=)1
xport supply function
using cointegration. +
sectors.
'mport functions
Golub '1,,,( $,.,5 to ,.61 ,.*6 to ).,/ %anufacturing
SenhadDi ')**+( $).,/ in ?!
$,.// in S!
,..- 7bs E 6/ %ulti$country study
Smal ')**.( $,.-5 )./+ )*-5K) to )**/K/ %erchandise imports
excluding oil
Aahn ')*-+( $).)5 1.). %anufacturing
Fotes= ?! is long run, S! is short run.
xport demand elasticities have been estimated using numerous different specifications and
econometric techni:ues. The estimated long$run export price elasticities of demand range
from C,./ to C., with lower estimates in the short run.
All estimates, apart from "ehar and dwards '1,,6(, either impose the assumption of
infinite export supply, or estimate a reduced form of the export function. As discussed in the
empirical methodology section, this induces simultaneous e:uation bias into the estimate. A
contribution of this study is that it estimates the supply and demand functions as a set of
simultaneous e:uations.
The approach of estimating export demand functions is also inconsistent with the view that
South Africa is a small country facing an infinite demand for exports. A further problem
with most of these estimates is that their relative price variable 'the real effective exchange
rate( is constructed using consumer prices, producer prices or unit labour costs as the price
variables, rather than export prices. These alternative prices include non$traded products and
do not necessarily reflect changes in the relative price of South African exports measured in
the foreign currency.
This is a severe limitation as it is not clear whether the estimated price elasticities are
demand or supply elasticities. 4or example, the studies of Golub '1,,,(, Golub and
11
8eglows#i '1,,)( and dwards and Golub '1,,1( use a !! constructed from unit labour
costs, i.e.
E .:
f
$!
e;L
;L
<EE<

where ;L is the unit labour cost and e

is the exchange rate. The subscripts $! and f refer to
South Africa and foreign countries, respectively. In these studies, a depreciation of the
currency and>or a decline in J?8 in South Africa is interpreted as an improvement in export
competitiveness, i.e. there is full pass$through into the price of exports measured in foreign
currency. xport growth responds, as it also suggested by the estimated coefficients which
range between C,.+- to C1.+..
9owever, in a small country export prices move in conDunction with the exchange rate 'as
shown in case ) of the theory section(, i.e. dPx/P E de/e. In the event of a depreciation, the
price of exports increases by the amount of the depreciation, but unit labour costs do not as
they are a non$traded factor. d.;L
$!
/Px-, which is e:uivalent to d.;L
$!
/e- in a small
country in the long run, falls implying profitability of export production has risen. xports
respond, not because foreign demand increases, but because export supply increases. Similar
arguments can be made for studies using !! calculated with 83I or 33I indices, as these
indices also contain prices of non$traded products. The estimated price elasticities of
demand in many of the South African studies may really be supply elasticities.
"ehar and dwards '1,,6( utilise multivariate cointegration techni:ues to estimate export
demand elasticities for South African manufacturing exports. The estimated long$run
elasticities range between C6 and C.. These elasticities are very high suggesting that South
Africa approximates a small country. A preferred specification of the export demand
function is one in which the export price is the normalised variable 'see later(. This would
enable a direct testing of the small country hypothesis.
4ewer studies have attempted to estimate export supply elasticities and import demand
elasticities. "horat ')**-( estimates supply elasticities for + manufacturing sub$sectors. The
results are largely poor with only / of the sectors showing significant coefficients of the
correct sign. 4urther, many of the coefficients on the domestic price variable are negative,
which is inconsistent with theory. These problems possibly relate to the very short time
period ')**, C )**5( over which the analysis was conducted. This period is inade:uate to
estimate long$run relationships. Supply elasticities for manufacturing have also been
estimated by "ehar and dwards '1,,6( using :uarterly data between )*+5 and 1,,,. The
estimated long$run price elasticities of supply range between ,.+. and ).6. The export price,
however, is incorrectly measured in foreign currency rather than in domestic currency.
stimated long$run import demand elasticities range between C,.-5 and $).)5. I SenhadDi
')**+( estimates the short$run import demand elasticity to be C,.//. Thus, in the short run
the domestic currency value of imports appears to rise in response to a devaluation, but
declines slightly or remains constant in the long run.
Together the import demand and export elasticities suggest that a depreciation improves the
trade balance in South Africa. Imposing the small country assumption and substituting the
average long$run import demand '$).,)( and export supply ').)/( elasticities into : ,,
16
yields a long$run exchange rate elasticity of the trade balance 'E
!
( e:ual to 1.)5.
*
A ) 0
depreciation thus improves the trade balance by 1.)5 0 'of the value of imports( in the long$
run. The average short run elasticities of import demand and export supply are C,.// and
,.-6, respectively. This yields a trade balance elasticity e:ual to ).1+. Thus, the short$run
impact of a depreciation on the trade balance is less than the long$run impact, but both
appear positive.
The positive impact on the trade balance is also the conclusion drawn by Smal ')**.(.
9owever, the si&e of the improvement depends on how domestic prices and wages respond
to the depreciation. Jsing an econometric macro$economic model, Smal ')**.( shows that
a depreciation without restrictive fiscal and monetary policy can result in a substantial
increase in inflation. This negatively affects income and employment relative to a scenario
where wage growth is moderated and government expenditure fell in real terms. Strangely,
the current account balance declined relative to the inflation simulation.
3, !ac&ground data analysis
This section provides a cursory overview of South African export and import trends since
the early )*+,s. A primary obDective is to obtain some preliminary insights into the
relationship between export performance and competitiveness vis$B$vis international
producers and vis$B$vis production for the domestic mar#et. Increased competitiveness vis$
B$vis international producers influences exports according to the export demand function.
Improved profitability in the production of exports relative to domestic goods positively
affects export supply.
A clear understanding of these relationships is essential for the initial specification of the
export demand and supply functions that are to be estimated. As discussed in the
methodology section, if firms are found to be a Oprice$ta#erL in international mar#ets, i.e.
export and import prices are fixed in foreign currency prices, domestic export prices rise by
the full depreciation of the currency and exports increase because domestic production
thereof has become relatively more profitable. In this case it is appropriate to estimate the
export supply function while assuming an infinite demand for exports.
Alternatively, if domestic exporters are found to have some pricing power, through product
specialisation and>or a large share in world exports, a depreciation lowers the foreign
currency price of South African exports and the :uantity of exports demanded increases.
The extent of the increase depends on the elasticity of demand. In these cases it is
appropriate to estimate to both supply and demand curves 'assuming export supply is not
infinite(.
"ata
Iarious sources of data were utilised in this study. The selection of data was determined by
a number of criteria.
4irstly one of the obDectives of the study is to estimate long$run structural elasticities of
supply and demand for exports and imports. This re:uires data over a sufficiently long
time period.
*
In accordance with the earlier argument, the demand elasticities estimated using !! have been
interpreted as supply elasticities.
1/
Secondly, the statistical techni:ues utilised in this study re:uire numerous data points as
the IA! estimation techni:ues result in a substantial loss in degrees of freedom.
),

Thirdly, an obDective is to assess the sensitivity of the estimated elasticities and the
impact of exchange rate movements on different classifications of export and imported
goods.
Given these conditions, it was decided to utilise annual data between )*5, to 1,,) and
:uarterly data between )*+,:) to 1,,):/. 8onsistent export and import data over these
periods are obtainable for non$gold merchandise goods and manufacturing goods. In
addition to import and export data, numerous other data, as specified in the export ': ,(
and import functions ': ,( are re:uired. Table 1 presents the names, sources and
construction details of the variables used in the estimates presented in this study.
Table -: 4ariable names, descriptions and data sources
4ariable 4ariable description Source
Export functions
3H xport unit value price, excluding gold ')**5E),,, seasonally
adDusted(
SA!" Kuarterly "ulletin 'S$,-+(
3H%TI3S %anufacturing export price series merged from=
')( xport prices obtained from TI3S SAI2, )*--:)$1,,,:/
'1( xport price index 'various base years( obtained from SSA,
)*+5:) C )*-+:/
TI3S SAI2, SSA
HI7? SA export volume excluding gold ')**5E),,, seasonally adDusted( SA!" Kuarterly "ulletin 'S$,-+(
HIA? SA exports of goods and services including gold '! millions
constant )**5 prices(
SA!" Kuarterly "ulletin 'S$)))(
H%TI3S %anufacturing real export series merged from=
')( !eal exports in )**5 prices obtained from TI3S SAI2, )*--:)$
1,,,:/
'1( xport volume index 'various base years( obtained from SSA,
)*+5:) C )*-+:/
TI3S SAI2, SSA
33I27% P
3%27%
3roducer price index for output of South African industry $ 4or
South African consumption ')**5E),,(
SSA= 3,)/1.)
33I47! Geighted average foreign producer price index I4S
!AT Fominal effective exchange rate. See Table - for weights. I4S, SA!"
MSTA! weighted :uarterly index of real gross domestic product ')**5E),,(
of foreign countries. See Table - for weights.
I4S, SA!"
G23SA South African gross domestic product ')**5E),,( SA!"
G2393 Trend G23SA calculated using a 9odric#$3rescott filter with
E).,,,
TA!I44IF8 Kuarterly index of SA collection rate including surcharges from
)*-5 C )**+. 8ollection rate calculated as duties
collected>merchandise trade.
SA!"
J?8 Seasonally adDusted= Fominal unit labour costs ')**5E),,,
seasonally adDusted(
SA!" Kuarterly "ulletin 'S$)6/(
Import e"uations
%I7? SA import volume ')**5E),,, seasonally adDusted( SA!" Kuarterly "ulletin 'S$,-+(
%IA? SA imports of goods and services '! millions at constant )**5
prices(
SA!" Kuarterly "ulletin 'S$)))(
%%AF %anufacturing imports in constant )**5 prices converted to index,
)*+,$1,,), annual only
TI3S SAI2
3I% 3JI Import unit value price ')**5E),,, seasonally adDusted( SA!" Kuarterly "ulletin 'S$,-+(
3I% 33I 33I= Imported commodities ')**5E),,( SSA= 3,)/1.)
3%%AF %anufacturing import prices, )*+,$1,,), annual only TI3S SAI2
G2%AT3 xpenditure on gross domestic product at mar#et prices '! millions,
seasonally adDusted at annual rate(
SA!" Kuarterly "ulletin 'S$)))(
),
"oth the first and the second condition are important. "horat ')**-( estimates export supply functions for
South Africa over the period )**, to )**5 using monthly data. Ghile this provides sufficient data points, the
period of analysis is too short to derive long$run relationships.
15
#thers
!!HJI !eal effective exchange rate constructed using 3H, !AT and
foreign export unit values. See Table - for weights.
I4S, SA!"
!!83I !eal effective exchange rate constructed using 3H, !AT and
foreign 83I. See Table - for weights.
I4S, SA!"
!!33I !eal effective exchange rate constructed using 3H, !AT and
foreign 33I. Geighted using bilateral imports plus exports. See
Table - for weights.
I4S, SA!"
3HJI327% 3H>33I27%
Fotes= All variables are in natural logarithms.
SA!"= South African !eserve "an#
SSA= Statistics South Africa
I4S= International 4inancial Statistics
TI3S SAI2= Trade and Industrial 3olicy StrategiesL South African Industrial 2atabase.
$outh !frican export and import performance
**
4igure 5 and 4igure . compare merchandise and manufacturing exports and imports for
South Africa from )*+,. A number of trends in South AfricaLs trade performance are
evident.
4irstly, export growth stagnated during the )*+,s and early)*-,s, but rose rapidly
subse:uently.
Secondly, import levels showed no sustained trend during the )*+,s and )*-,s, but rose
sharply during the )**,s.
Thirdly, manufacturing exports grew very strongly relative to total exports from the
mid$)*-,s. !eal manufacturing exports grew by more than *,, 0 between )*-5 and
1,,).
Figure 3: 5erchandise #incl, gold$ and manufacturing exports in constant +663 prices
Source= %erchandise export data 'excluding service payments, but including gold exports( are obtained from
the !eserve "an# Kuarterly "ulletin 'HIA?( and %anufacturing exports are obtained from TI3S SAI2.
))
4or a more detailed analysis of trade flows and structural changes in the composition of production and
exports see dwards '1,,)( and dwards and Schoer '1,,1(.
1.
*erchandise and #anufacturing exports ($ billion in constant 1995 prices)
0
20
40
60
80
100
120
140
160
1
9
7
0
1
9
7
2
1
9
7
4
1
9
7
6
1
9
7
8
1
9
8
0
1
9
8
2
1
9
8
4
1
9
8
6
1
9
8
8
1
9
9
0
1
9
9
2
1
9
9
4
1
9
9
6
1
9
9
8
2
0
0
0
0
10
20
30
40
50
60
70
80
90
100
Merc+a(,i-e exp&r/- 20+-3 Ma(u4ac/uri(5 exp&r/- 2r+-3
Figure 7: 5erchandise and manufacturing imports in constant +663 prices
Fotes= %erchandise imports are %IA? excluding service payments 'see Table 1(. %anufacturing imports are
%%IA? in constant )**5 prices.
The figures reflect a change in the composition of exports away from mining towards
manufactures. 3rior to the mid$)*-,s, mining sector exports '+) 0 of total export of goods
in )*-5( and notably gold exports 'gold and uranium accounted for /6 0 of South African
exports, excluding services, in )*-5( dominated total exports. As a result, the fall in the gold
price in the early )*-,s had a drastic impact on the economy. Ghile the JS dollar value of
exports of mining grew at an annual rate of 1/..0 between )*+,$-,, it fell by C*.)0 per
annum between )*-, and )*-5 '"ell, )**1= ))(. The decline of the mining sector continued
during the rest of the decade and into the )**,s. "y 1,,, the mining sector share of total
exports had fallen to 61 0 with the share of gold and uranium falling to )6 0.
)1

In contrast, manufacturing exports grew strongly from the mid$)*-,s, both in real terms and
as a share of G23 'see 4igure +(. %anufacturing exports grew in real terms at an average
annual compound growth rate of + 0 between )*-5 and )**6. As a result, the share of
manufacturing in total goods exports rose from 1. 0 to /, 0 during this period. Since
)**/, manufacturing export growth accelerated to )1.5 0 per annum and has become the
dominant source of export revenue. In 1,,, manufacturing exports accounted for ./ 0 of
total export revenue 'excluding services(. There was also a trend towards greater export
diversification with strong growth in non$traditional exports '"lac# and Aahn, )**-(.
)1
stimated using data obtained from TI3S SAI2.
1+
*erchandise and #anufacturing i#ports ($ billion in constant 1995 prices)
0
20
40
60
80
100
120
140
1
9
7
0
1
9
7
2
1
9
7
4
1
9
7
6
1
9
7
8
1
9
8
0
1
9
8
2
1
9
8
4
1
9
8
6
1
9
8
8
1
9
9
0
1
9
9
2
1
9
9
4
1
9
9
6
1
9
9
8
2
0
0
0
0
20
40
60
80
100
120
140
Merc+a(,i-e i6p&r/- 20+-3 Ma(u4 ac/uri(5 i6p&r/- 2r+-3
Figure 8: Exports and imports as a share "9P
Fotes= As in 4igure 5.
The increased export orientation of South African manufacturing producers is reflected in
the rising share of manufacturing exports in G23 from under 5 0 in )*-5 to approximately
)5 0 in 1,,, 'see 4igure +(. A more appropriate indicator of export orientation is the share
of manufacturing output exported 'exports>gross output(, which rose from ),.1 0 to 1+.5 0
between )*-5 and 1,,,.
)6

Import growth has shown a similar trend to manufacturing exports with very strong
increases occurring from the early )**,s. !eal imports grew at an average annual rate of /.+
0 between )*-5 and )**6, but at 5.6 0 between )**6 and 1,,). As shown in 4igure .,
very high growth occurred between )**6 and )**+. Strong growth in imports relative to
output has raised import penetration 'imports>'output$exportsNimports(( from )- 0 in )**,
to 61 0 in 1,,,. This is also reflected in the rise in the ratio of imports to G23 shown in
4igure +.
(actors influencing $! export performance
Iarious factors have played a role in the promotion of export growth since the mid$)*-,s.
These factors can be categorised as either influencing the demand for exports or the supply
of exports.
7n the export demand side, most of the focus has been on increasing price or cost
competitiveness of South African products measured in a common currency 'Aahn, )**-Q
Galters and de "eer, )***Q Golub, 1,,,(. A measurement used for this type of analysis is
the real exchange rate, which is calculated as 3 4 ep/p* where the exchange rate, e, is the
foreign currency per unit domestic currency, and p/p* is the ratio of domestic prices 'costs(,
p, to foreign prices 'costs(, p*. Assuming imperfect substitutability between traded goods
)/
,
if domestic prices, p, rose faster than foreign prices, p*, the real exchange rate, 3, would
)6
stimated using data obtained from TI3S SAI2.
1-
Exports and i#ports as a share .) (constant 1995 prices)
07
57
107
157
207
257
1
9
7
0
1
9
7
2
1
9
7
4
1
9
7
6
1
9
7
8
1
9
8
0
1
9
8
2
1
9
8
4
1
9
8
6
1
9
8
8
1
9
9
0
1
9
9
2
1
9
9
4
1
9
9
6
1
9
9
8
2
0
0
0
&/a0 exp&r/-.)"P Ma(u4ac/uri(5 exp&r/-.)"P &/a0 i6p&r/-.)"P
appreciate 'rise( reflecting a decline in competitiveness of domestically produced goods. 4or
an analysis of global competitiveness a weighted composite index of all bilateral real
exchange rates, the real effective exchange rate '!!(, is used.
There are various estimates of the !! for South Africa using different price indices
'producer price indices, value added deflators, unit labour costs, consumer price indices(,
different weighting procedures 'exports, imports, exports plus imports( and different
samples of competing countries.
)5
The studies generally show that the !! appreciated
during the )*+,s with the rise in the gold price, but declined sharply in the mid -,s driven
largely by the collapse in nominal exchange rate. !elatively high inflation in SA and large
inflows of portfolio capital during the late )*-,s appreciated the !! 'Tsi#ata, )***(.
Since )**1 the !! once again declined, although its movements have been highly
volatile, particularly in )**. and )**+.
%ost studies also find a negative relationship between the !! and export performance.
4allon and de Silva ')**/(, Tsi#ata ')***( and Golub '1,,,( estimate !! elasticities of
exports between ,..6 and )./. A one percent decline in !! ')0 improvement in
competitiveness( is estimated to raise manufacturing exports by between ,..6 0 and )./ 0.
9owever, as discussed in Section /, these elasticities may reflect supply elasticities.
To analyse the change in competitiveness of South African exports, !! are re$calculated
using South African export unit values and a range of foreign prices 'see 4igure -(. The
indices show the price of South African exports relative to foreign producer prices 'rerppi(,
foreign consumer prices 'rercpi( and foreign export unit values 'rerxuv(.
).
The sample of
countries, used for the calculations, was selected on the basis of data availability and
importance in total South African trade. The countries and weights are presented in the
Appendix in Table -.
As found in other studies, the !! remained constant or rose during the late )*+,s, but
fell as the currency depreciated during the )*-,s. 3articularly large declines occurred in
)*-5 as a result of the nominal depreciation following the !ubicon speech and the debt
crisis. The picture during the )**,s is less clear and the trend in !! is strongly
influenced by the choice of foreign price index. !! calculated using foreign 83I show a
continued decline during the )**,s. In comparison, the !! calculated using foreign 33I
or export unit values has not shown a substantial decline since )**/.
Figure :: Real effective exchange rates using various price indices, uarterly data
)/
If traded goods were perfect substitutes or purchasing power parity held, then 3 would not vary over time
'Golub, 1,,,= ),(.
)5
See Golub '1,,,( for an overview of !!s calculated using these different techni:ues.
).
Jnit value indices are constructed by dividing the value of imports 'exports( by the physical :uantities of
imports 'exports(. This can lead to OspuriousL price indices as changes in the composition of trade can affect
the unit value index, even if the OtrueL prices do not change 'Goldstein and Aahn, )*-5= ),55(.
1*

Log real effective exchange rates (1995=log(100))
4.00
4.20
4.40
4.60
4.80
5.00
5.20
5.40
M
a
r
-
7
5
M
a
r
-
7
7
M
a
r
-
7
9
M
a
r
-
8
1
M
a
r
-
8
3
M
a
r
-
8
5
M
a
r
-
8
7
M
a
r
-
8
9
M
a
r
-
9
1
M
a
r
-
9
3
M
a
r
-
9
5
M
a
r
-
9
7
M
a
r
-
9
9
M
a
r
-
0
1
rerppi rercpi rerxuv
Sources= See Table 1.
Fotes= ach index is calculated as the unit value index of SA merchandise exports relative to a weighted
average foreign prices. rerppi uses foreign producer prices, rercpi uses foreign consumer prices and rerxuv
uses foreign export unit value indices. The sum of exports and imports are used as weights 'see Table -(.
!eductions in the !! in response to exchange rate depreciations are dependent on the
pass$through of the depreciation onto foreign prices. If exporters price according to the
small country model, a depreciation will not lower the !! and international price
competitiveness will not improve. Although sharp depreciations occurred during )**., )**-
and 1,,), the gains in competitiveness appear to have been :uic#ly eroded by nominal
appreciations and export price increases. These results suggest that the improved export
performance during the )**,s cannot be fully explained by improved international price
competitiveness. "ecause of the importance of the pricing behaviour for the specification of
the demand and supply functions, the pass$through of exchange rate depreciations will be
explored in more detail later. Fevertheless, the evidence suggests that South African
exporters price according to the small country model, at least during the )**,s.
xport growth can also arise from supply side factors. Supply side dynamics have been
ignored in much international empirical literature and the ;bul= of the time>series wor= on
import and export e3uations has addressed the supply side only by assumption< 'Goldstein
and Aahn, )*-5= ),/-(. As Goldstein and Aahn ')**5= ),/-( note= ; Even if the country is
?small) in the sense that it cannot affect the foreign currency prices of either its imports or
its exports, it can still affect its export volume to the extent that it can affect the internal
profitability of producing and/or selling exportables<.
8hanges in the overall and relative profitability of export production appear to explain some
of South AfricaLs improved export performance. 2uring the )*-,s South African
manufacturing firms shifted to the export mar#et as the recession hit domestic demand.
4aced with rising unused capacity, the export mar#et served as a Ovent$for$surplusL capacity
'"elli et al., )**6Q 4allon and 3ereira de Silva, )**/(.
)+
The growth in manufacturing
exports occurred despite the imposition of sanctions.
2uring the early )**,s, the export subsidies provided under the Generalised xport
Incentive Scheme 'GIS( played a #ey role in ma#ing exports profitable '"elli et al., )**6(.
Although this was phased out in )**., continued tariff liberalisation has substantially
reduced the anti$export bias associated with tariff protection 'see Ian Seventer, 1,,)(.
Tsi#ata ')***( finds that tariff reductions positively affected export performance.
The depreciation of the currency is a further factor raising the relative profitability of export
production. As the currency depreciates, export prices rise relative to non$tradables and
goods produced for the domestic mar#et. Thus, ;U. a devaluation can nevertheless have
some potency @ via its impact on the internal terms of trade between exports and
nontradables< 'Goldstein and Aahn, )**5= ),/-(. 4ollowing the I%4 ')**-(, 4igure *
presents a relative profitability index for domestic and export production. The profitability
index is constructed as the ratio of export and producer '33I( prices to unit labour costs.
)+
mpirical evidence in support of the Ovent$for$surplusL hypothesis is ambiguous. 4allon and 3ereira da Silva
')**/( and dwards and Golub '1,,1( find a negative relationship between exports and capacity utilisation.
"ehar and dwards '1,,6( and Tsi#ata ')***( finds no relationship.
6,
Figure 6: Relative profitability indices
Fotes= 33I is the producer price index for South African output for domestic consumption. Jnit labour cost is
obtained from the !eserve "an# Kuarterly "ulletin.
The profitability index of merchandise exports fluctuates substantially more than for
domestic production and reflects the close relationship between export prices and the
exchange rate. The substantial depreciation during )*-5 raised export prices relative to
domestic producer prices and unit labour costs. The improvement in relative profitability of
export production is consistent with the surge in manufacturing exports experienced during
the mid$)*-,s. 2uring the rest of the )*-,s, strong wage growth combined with low
productivity growth and slow growth in export prices caused the profitability index for
domestic production and exports to converge. The decline in export prices is consistent with
pricing pressures arising from discounting in order to access the international mar#et as a
Ovent$for$surplusL capacity. As "elli et al. ')**6= 1.( note= ;!s long as export sales covered
variable costs, firms accepted export orders< during this period.
The profitability of domestic and export production improved from )**6, driven by
improved domestic demand and rising labour productivity.
)-
Gith the continued
depreciation of the currency, improved profitability of export production exceeded that of
domestic production. xport supply responded, as is reflected in the improved export
performance.
(actors influencing $! import performance
Imports are heavily concentrated on capital and intermediate goods and reflect the high
import dependency of the capital$intensive basic metals and chemicals subsectors. The
import share of intermediate and capital goods rose strongly from the )*+,s to the mid
)*-,s as the governmentLs import substitution policies shifted towards deepening import
replacement in downstream industries '4allon and 3ereira de Silva, )**/= +5(. In addition,
heavy investment in Ostrategic industriesL such as IS87!, SAS7? and %7SSGAS raised
the capital intensity of domestic production 'see dwards, 1,,)b(. In )*-- capital and
)-
See dwards and Golub '1,,1( for an international comparison of unit labour costs.
6)

$elative profitabilit- index (1995=1)
0.6
0.8
1
1.2
1.4
1.6
1.8
M
a
r
-
7
0
M
a
r
-
7
2
M
a
r
-
7
4
M
a
r
-
7
6
M
a
r
-
7
8
M
a
r
-
8
0
M
a
r
-
8
2
M
a
r
-
8
4
M
a
r
-
8
6
M
a
r
-
8
8
M
a
r
-
9
0
M
a
r
-
9
2
M
a
r
-
9
4
M
a
r
-
9
6
M
a
r
-
9
8
M
a
r
-
0
0
M
a
r
-
0
2
Merc+a(,i-e Px.u(i/ 0a1&ur c&-/ PP!.u(i/ 0a1&ur c&-/
intermediate good imports accounted for +- 0 of total imports, but this has subse:uently
fallen 'to +1 0 in )**+( reflecting increased imports of consumption goods.
)*

The high intermediate and capital intensity of imports suggests that total imports are
strongly influenced by domestic output and investment growth. This relationship is reflected
in 4igure . during the )*-,s and early )**,s where poor economic growth depressed import
growth. The imposition of surcharges during the late )*-,s will have further depressed
import growth. Since )**/ import growth has surged and has exceeded output growth. This
growth is attributed to a resurgence in deferred investment 'Tsi#ata, )***( and reduced
costs of imports from trade liberalisation.
The exchange rate is also expected to be an important determinant of import growth as a
depreciation causes firms and consumers to substitute domestic for imported goods.
mpirical evidence of this relationship is mixed in South Africa. Golub '1,,,( estimates
import demand functions for South Africa between )*+, and )**+ and finds the expected
positive coefficient 'e:ual to one( for G23 and negative coefficient for tariffs. 9owever, the
coefficient on the !! was of the incorrect sign, suggesting that a depreciation increases
import demand. Aahn ')*-+(, Smal ')**.( and SenhadDi ')**+( also estimate import
demand functions and find import demand elasticities of the correct sign ranging between C
,.-5 and C).)5.
Exchange rate and the balance of trade
In this section, the relationship between the trade balance and the exchange rate are explored
in more detail. 4igure ), presents the trade balance calculated as the logarithm of the ratio
of exports to imports, measured in current values.
1,
Jsing this method, the trade balance is
invariant to whether the data are expressed in domestic or foreign currency.
As shown in 4igure ),, for most years the trade balance for merchandise goods as been in
surplus. In contrast, the trade balance for manufactures has been in deficit. There is no clear
trend in the trade balance for merchandise goods. 2uring the mid$)*-,s, the merchandise
trade balance improved. This improvement is consistent with the depreciation of the
currency during the mid$)*-,s, but is also the result of a decline in imports arising from the
severe domestic recession, the decline in investment and the imposition of surcharges on
imported products. The manufacturing trade balance showed a dramatic rise in )*-5, and
has continued on an upward trend subse:uently. The upward trend has continued despite a
slight recovery in economic growth since )**/ and a reduction in tariff rates.
)*
2ata obtained from "ell ')**1( and the Input$7utput tables provided by Statistics South Africa and G4A
have been used to estimate the share of intermediate and capital goods in total imports.
1,
There is no consistency on how the trade balance is calculated. "ahmani$7s#ooee ')*-5( uses the nominal
value of net exports, !ose ')**,( uses a particular approach to deflate the trade balance to obtain the real
value, and 9aynes and Stone ')*-1(, "ahmani$7s#ooee ')**)(, Shirvani and Gilbratte ')**+( and 9ossain
')***( use the logarithm of the ratio of nominal exports to imports.
61
Figure +.: 5anufacturing and merchandise trade balance
Source= see Table 1.
Fotes= %erchandise trade balance excludes service payments, but includes gold. The trade balance is
calculated as ln'exports>imports( using nominal values.
A more rigorous approach is to compare trends in the trade balance with trends in the !!
and the relative price of exports to domestic producer prices '3x>3domestic(. This is the
approach followed in much empirical research on the effect of the exchange rate on the
trade balance '"ahmani$7s#ooee, )**)Q Shirvani and Gilbratte, )**+Q 9ossain, )***(.
2eclines in the !! reflect increased international price competitiveness 'demand effect(
and increases in 3x>3domestic reflect increased profitability of export production compared
to domestic production 'supply effect(. 4igure )) and 4igure )1 display these relationships
for merchandise trade 'including gold( and manufactures. Although the price of imports
relative to domestic goods is not shown, this ratio closely follows that of 3x>3domestic. An
increase in 3x>3domestic is thus expected to positively affect the trade balance both through
increased exports supplied and a substitution away from imported goods towards domestic
goods.
Figure ++: 5erchandise trade balance and relative price indices
66
*erchandise trade balance and relative price indices
-0.3
-0.1
0.1
0.3
0.5
0.7
0.9
1.1
1.3
1.5
1
9
6
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3
1
9
6
6
1
9
6
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2
1
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1
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3
1
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1
9
9
9
4.2
4.3
4.4
4.5
4.6
4.7
4.8
4.9
5.0
5.1
5.2
Merc+a(,i-e /ra,e 1a0a(ce Px.P4&rei5( 2r+-3 Px.P,&6e-/ic 2r+-3
(rade balance/ ln(exports0i#ports)
-1.50
-1.00
-0.50
0.00
0.50
1.00
1
9
7
0
1
9
7
2
1
9
7
4
1
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6
1
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1
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1
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1
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1
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9
6
1
9
9
8
2
0
0
0
Merc+a(,i-e /ra,e 1a0a(ce Ma(u4ac/uri(5 /ra,e 1a0a(ce
Fotes= The trade balance is calculated as ln'exports>imports( using nominal values of trade in goods.
3x>3foreign is calculated as ln'3H>33I47!(. 3x>3domestic is calculated as ln'3H>33I27%(. See Table 1
for details regarding the variables and sources of data.
Fo clear relationship between the trade balance and the relative price indices is evident over
the entire period. 2uring the )*.,s the decline in the merchandise trade balance is
consistent with the decline in 3x>3domestic, but not with the improved competitiveness as
reflected in the decline in the !! '3x>3foreign(. 2uring the )*+,s no relationship is
evident. 4rom the mid$)*-,s, trends in the merchandise trade balance are consistent with
trends in 3x>3domestic. "oth the trade balance and the price of exports relative to domestic
products rose in the mid$)*-,s and then gradually declined till the early )**,s. The price of
imports relative to domestic products also fell during this period, which will have negatively
affected the trade balance through raising imports.
1)
The decline in the trade balance
occurred despite the improved international competitiveness shown in the falling price of
exports relative to foreign producer prices '!!(. 2uring the late )**,s the trade balance
improved which is consistent with both the decline in the !! and the rise in
3x>3domestic.
These results suggest that changes in the merchandise trade balance are largely affected by
changes in the supply of exports and changes in the relative price of imports. Ghile the
significant depreciation during the$mid )*-,s boosted exports and reduced imports, strong
price increases for domestic products relative to export products reduced the relative
profitability of export production 'also shown in 4igure *( and boosted imports. The trade
balance thus declined till the early )**,s. The interaction between the exchange rate and
domestic and export prices thus plays an important role in determining the responsiveness of
export supply to a depreciation. A depreciation raises the relative profitability of export
production, but the improved profitability can :uic#ly be eroded by domestic inflation.
Figure +-: 5anufacturing trade balance and relative price indices
Fotes and sources= As in 4igure )) except 3x is the export price deflator for manufacturing obtained from
dividing the current value of exports by the real value of exports. The data are obtained from TI3S SAI2.
1)
The !! calculated using South African and 4oreign producer prices shows a rise 'real appreciation(
between )*-. and )**1. This is also consistent with the declining trend in the trade balance during the
period.
6/
*anufacturing trade balance and relative price indices
-1.5
-1.3
-1.1
-0.9
-0.7
-0.5
-0.3
-0.1
0.1
0.3
0.5
1
9
7
0
1
9
7
2
1
9
7
4
1
9
7
6
1
9
7
8
1
9
8
0
1
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1
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1
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1
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1
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0
1
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1
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1
9
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2
0
0
0
4.0
4.2
4.4
4.6
4.8
5.0
5.2
5.4
ra,e 1a0a(ce 20+-3 Px.P4&rei5( 2r+-3 Px.P,&6e-/ic 2r+-3
As with merchandise trade, no clear trend between the manufacturing trade balance and the
relative price indices is evident during the )*+,s. 4rom the mid$)*-,s to the early )**,s,
the improved trade balance is consistent with the decline in 3x>3foreign, but not the decline
in 3x>3domestic. Since )**1, continued declines in 3x>3foreign and the rise in
3x>3domestic are consistent with the improvement of the trade balance.
Exchange rate pass>through analysis
The above analysis suggests that export prices in South Africa are determined according to
the Osmall countryL model and that exports adDust according to the export supply function.
4urther, in preliminary estimates of the export demand and supply functions, it was
fre:uently impossible to derive economically interpretable coefficients for the demand
function. This led to further graphical 'and econometric analysis( to assess the pricing
behaviour of South African exporters. If South African exporters are price$ta#ers in the
international mar#et, the demand for South African exports is infinite and the SA export
price is determined by foreign prices measured in the domestic currency.
4igure )6 presents the time series plots of the export prices '3H(, domestic prices
'33I27%(, the nominal effective exchange rate '!AT( and a weighted average of
foreign prices '33I47!(. 4urther details on the construction of these series are provided in
Table 1. According to the small country model, changes in the exchange rate or foreign
prices are fully transferred into export prices measured in the local currency. This
relationship is evident from the )*-,s with the exchange rate and merchandise export unit
values 'excluding gold( closely trac#ing one another. 2uring periods of currency
depreciation the export price and the exchange rate rise relative to the domestic price. This
is particularly noticeable during the mid$)*-,s and the late )**,s. Although not shown,
manufacturing export prices follow a very similar trend to merchandise export unit values.
Figure +/: Time series plot of price and exchange rate variables
Fotes= See Table 1 for further details on variables.
65
Exchange rate and pass1through effects
2
2.5
3
3.5
4
4.5
5
5.5
6
8
a
(
-
7
5
8
a
(
-
7
7
8
a
(
-
7
9
8
a
(
-
8
1
8
a
(
-
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3
8
a
(
-
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8
a
(
-
8
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8
a
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-
8
9
8
a
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-
9
1
8
a
(
-
9
3
8
a
(
-
9
5
8
a
(
-
9
7
8
a
(
-
9
9
8
a
(
-
0
1
PX PP!"OM ERAE PP!9OR
4ollowing Swift ')**-(, exchange rate pass$through e:uations are also estimated for
merchandise and manufacturing exports. These are not shown as similar relationships are
estimated later when estimating the export functions. The estimated long$run elasticity of
domestic$currency prices with respect to the exchange rate ranges between ,.+ to ,.*. This
implies that a ) 0 depreciation of the currency raises export prices by between ,.+ 0 and
,.* 0. The difference reflects the pass$through onto international prices, i.e. domestic
exporters reduce foreign$currency price of their exports by ,.) 0 to ,.6 0 in response to a )
0 depreciation. The pass$through is substantially less than the ., 0 estimated by Swift
')**-( for Australia.
The close association between export unit values and the exchange rate is consistent with
the small$country model where the pass$through to foreign prices is &ero. These results
suggest that it is appropriate to estimate the export supply function independently of export
demand function.
.1 !iscussion
This section presented a graphical analysis of various factors, and in particular the exchange
rate, on South African export and import performance since the )*+,s. Iarious conclusions
emerge from the analysis.
xport and imports remained relatively stable during the )*+,s and early )*-,s, but
grew strongly from the mid$)*-,s. xport growth was particularly strong within
manufacturing which has become the dominant source of export revenue. Indicators of
openness 'exports and imports as a share of G23, import penetration and export
orientation( have also risen sharply, reflecting the rising importance of international
trade for the domestic economy.
xport growth appears to be driven by changes in the profitability of export supply,
rather than lower foreign currency denominated prices of South African exports,
particularly during the )**,s. This conclusion is based on the following relationships=
- South African export prices have not declined relative to foreign export prices
during the )**,s, despite the depreciation of the currency.
- xport prices closely follow movements in the exchange rate with export prices
rising by the full depreciation. South African exporters are thus price$ta#ers in the
international mar#et.
- 8hanges in the trade balance and export growth appear to be correlated with
improvements in the relative profitability of export production vis$B$vis domestic
production.
xchange rate depreciations positively affect exports by raising the price received by
domestic exporters. 9owever, fre:uently the improved profitability of export production
is eroded by domestic inflation and wage increases. Fo long$run deviation between the
exchange rate, export prices and domestic prices is found. As a result, no sustained
relationship between exchange rate movements and the trade balance is shown in the
diagrams.
In the following section, these relationships are analysed using econometric techni:ues.
6.
7, Results
$.1 %urther specification issues
The graphical analysis suggests that South African exporters are price$ta#ers in the
international mar#et. xport firms face an infinite demand for their products and the volume
of total exports is constrained by domestic export supply. Infinite price elasticity of export
demand implies that the coefficient
)
of export prices Px in the export demand e:uation :
, tends towards infinity.
!iedel ')*--( argues that in the small country case it is appropriate to normalise the export
demand e:uation on Px to obtain
E .:
S
)
)
/
)
6
)
1
) )
,
7 P erate % Px
d

+

,
This functional form enables the testing of the small$country hypothesis that demand is
infinitely elastic with respect to price as the coefficient on %
d
tends towards &ero, ')>
)
E ,(.
The impact of world income depends on both the income elasticity of demand '
/
( and the
price elasticity of demand '
)
(. The more elastic the demand curve the lower the impact of
world income on exports '!iedel, )*--= )/1(. In the small$country case the coefficients on
%
d
and 7* in : , are expected to be &ero. Similarly, exchange rate depreciation and foreign
price increases are expected to feed fully into domestic export prices. The coefficients on
the exchange rate and foreign prices are expected to e:ual one, i.e.
1
>
)
E
6
>
)
E $ ).
The specification of : , with &ero coefficients on %
d
and 7* is similar to the exchange rate
pass$through studies of Swift ')**-( and 9anninen and Toppinen ')***(. In these studies
export prices are regressed on the exchange rate, foreign prices and domestic and>or foreign
demand pressures. A coefficient of E ) on the exchange rate variable indicates the
domestic export price rises by the full depreciation of the domestic currency. If V ), some
of the depreciation is passed through to the international mar#et in the form of lower prices
measured in foreign currency. The pass$through of exchange rate changes to the destination$
currency prices of domestic exports is measured as )$. Swift ')**-( estimates a pass$
through rate of ., 0 for Australia, which OrefutesL the Osmall$countryL assumption of
Australian exporters as price$ta#ers.
All relationships were estimated using the @ohansen %aximum ?i#elihood procedure for
multivariate cointegration analysis. The econometric methodology is discussed in the
%ethodology Appendix A in Section -. In estimating the export functions, export demand
was normalised on Px, as outlined in : ,. xport supply was normalised on export
volumes, as specified in : ,. The export functions were estimated over various different
time periods using :uarterly and annual data, and in each case with various combinations of
variables. The functions were estimated for merchandise exports excluding gold as well as
manufacturing exports. The former includes non$gold mining and agriculture. In many cases
the estimations failed to provide theoretically consistent estimates of the structural
coefficients. The results often appear to be very sensitive to the selected order of the IA!
and the inclusion of different variables.
6+
In the analysis below, the results for merchandise exports using :uarterly data are discussed.
These estimates proved to be the most economically sensible and robust of the various
estimates for the export functions. Additional results for merchandise exports using annual
data and manufacturing exports using :uarterly and annual data are presented in Appendix
". The estimates for the import demand functions are presented after the results of the
export functions.
$.2 &erchandise exports' "uarterly data
Seven non$stationary I')( variables were included in the analysis=
HI7?= %erchandise export volume
3H= %erchandise export unit value
33I27%= 2omestic producer price index for SA goods produced for local consumption
!AT= Fominal effective exchange rate
33I47!= Geighted index of foreign producer prices
MSTA!= Geighted index of real foreign G23.
J?8= Fominal unit labour costs
In addition to these variables, an I',( trend variable for South African G23 'G2393( was
included. The 9odric#$3rescott filter, with E).,,,, was used to estimate the trend in SA
G23. Trend G23 is expected to positively affect export supply as ;U secular changes in
the level of aggregate real output will be accompanied by advances in factor supplies,
infrastructure, and total factor productivity that will lead to an increase in export supply at
any given level of export prices< 'Goldstein and Aahn, )*-5= ),.,(. 2ummy variables for
the sanction period ')*-.$1,,6( and the post$)**/ period were also included. 4urther,
numerous dummy variables were included to capture large shoc#s in the exchange rate. This
was necessary to reduce heteroscedasticity and non$normality of the residuals, particularly
of the !AT variable.
A second order IA! was selected, although serial correlation in the e:uation for 33I27%
remained. Increases in the IA! order induced serial correlation in the remaining variables.
Initial tests indicated that foreign income, MSTA!, was wea#ly exogenous and the system
was estimated with MSTA! as an exogenous variable 'see 3esaran and 3esaran, )**+=
1*+(.
11
Trends are included, but are restricted in the in the cointegrating vector.
In testing for the number of cointegrating vectors, the maximal eigenvalue and trace tests
statistics suggested 1 and 6 cointegrating vectors, respectively, at the 5 0 significance level
'see Table ))(. Three cointegrating vectors were selected and normalising restrictions were
imposed on 3H, HI7? and 33I27%. Two additional Dust$identifying exclusion restrictions
were imposed on each vector and are shown by the &eros in the first three columns of Table
6. The restrictions on the export price and export supply vectors were determined by the
export demand ': ,( and export supply ': ,( e:uations, respectively.
In the domestic price vector exclusion restrictions were placed on the HI7? and 3H and
the relationship is interpreted as a 333 relationship. The inclusion of this relationship is
particularly useful in this study, as rising domestic prices in response to an exchange rate
11
Fote that the treatment of all the remaining variables, particularly domestic prices and unit labour costs, as
endogenous deals with the criticism by Goldstein and Aahn ')*-5( that many studies treat these variables as
exogenous. Jsing this model it is possible to analyse how an exchange rate depreciation feeds into domestic
prices and thus erodes the profitability of export production.
6-
depreciation will erode the relative price shift '3H>33I27%( that induces a switch in
production towards the export mar#et. 9igh domestic price feedbac# reduces the
effectiveness of exchange rate depreciation in raising export production 'and reducing
import demand( and thus improving the trade balance. This lin#age is explicitly modelled.
The first three columns of Table 6 present the results with the Dust$identifying restrictions
imposed. The coefficient on the HI7? in the export price vector is low with high standard
errors. To test the small$country assumption the coefficient on HI7? was restricted to &ero.
This restriction could not be reDected, providing support for the hypothesis that South
African exporters are price$ta#ers in the international mar#et. The volume of exports is
supply determined and is dependent on the profitability of export production relative to
domestic production. These results are consistent with those found for 9ong Aong by
!iedel ')*--(.
6*
Table /: Estimated export functions for SA merchandise exports, uarterly data
+68+1%-..+1,
;ust%identified restrictions <ver%identified restrictions
9ependent
variable
Pexport =supply Pdomestic Pexport =supply Pdomestic
)4 + )4 - )4 / )4 + )4 - )4 /
HI7? $,.5+.) , , ,
5AB0C*
3H 1.11)/ , ).)16, ,
*A0CCD 5A0/2/
!AT ).165/ $).1+6/ ,.-,1/ ,.*1,) , ,.-)5.
5A/DCB 5ADC*D 5A/0*/ 5A*C:: 5A500B
33I27% , $).,//) , $,..16)
).-6-+ 5A/E/*
J?8 , $).1+.1 ,.,-1. , $,.6.,6 ,
*A*/52 5A/0B: 5A*:0/
33I47! ).66)+ , 1.)/5- ).51.* , 1.1*56
5AD::B 5A:D*2 5A/CC* 5A*5D:
MSTA! 6.-*,5 , $,.,*51 1.11-+ , ,
0ABCBD 5A:D*0 5A:55*
Trend $,.,5/, ,.,--. $,.,,)6 $,.,6,1 ,.,)1- ,
5A5/EB 5A5:*0 5A55DD 5A55D0 5A55E0
ecm)'$)( $,.6..+ W.,,)X $,.+115 W.,,+X $,.,)-5 W./*,X
ecm1'$)( $,.)//, W.,,*X $,.+1-* W.,,,X $,.,6,) W.,11X
ecm6'$)( ,.)/,1 W.),-X ,.5),* W.,)6X $,.,++5 W.,,,X
?! test of restrictions '
1
( Wp$valueX -.651, W.)6-X
IA! 6
Fote= The &eros reflect the combination of Dust$identified and over$identified restrictions. The price
homogeneity hypothesis, as tested by the restriction 'P% 6 PP1"O# 6 ;L E ,( could not be reDected 'the ?!
test statistic e:ualled *.65+ WpE,.11-X(.
Serial correlation was evident within the error correction e:uation for 33I27%.
These long$run coefficients are estimated with MSTA! wea#ly exogenous.
4urther over$identifying restrictions were imposed on each cointegrating vector. The final
three columns of Table )) present the long$run coefficients for the export price, export
supply and domestic price relationships. As shown by the ?! test statistic, the over$
identifying restrictions could not be reDected.
"oth domestic and export prices are strongly influenced by changes in the exchange rate. A
), 0 exchange rate depreciation raises export prices and domestic prices by *.1 0 and -.).
0 in the long run, respectively. The coefficient for export prices is consistent with the
small$country model whereby the pass$through of an exchange rate depreciation to
destination$currency prices of domestic exports is &ero. These estimates show a pass$
through of - 0 ') C ,.*1(, but this is not significantly different from &ero. This provides
further verification that South African exporters are price$ta#ers in the international mar#et.
As found in the results, export prices are more responsive to exchange rate changes than are
domestic producer prices. 2omestic producer prices include non$traded products, which are
/,
less affected by exchange rate movements. Fevertheless, domestic producer prices rise by
-).. 0 of the depreciation, which will substantially erode the benefit to exporters of the
exchange rate depreciation. A #ey difference, however, is the rate of convergence to the
long$run e:uilibrium. A comparison of the adDustment terms 'ecm) in the export price
vector and ecm6 in the domestic price vector( reveals a rapid convergence towards
e:uilibrium of export prices 'ecm) E $,.6+(, but a slow convergence towards e:uilibrium of
domestic prices 'ecm6 E $,.,-(. The relatively slow convergence to e:uilibrium of domestic
prices is also shown in 4igure )/, which presents the effect of a system$wide shoc# on the
long$run relations. ach profile is constructed so that it ta#es a value of ) at the time of the
shoc#. As shown in 4igure )/, export prices converge to e:uilibrium after . to + :uarters,
while domestic prices converge after approximately ). :uarters.
The price adDustment process thus identifies two avenues through which a depreciation
positively affects export performance=
4irstly, export prices rise by more than domestic prices.
Secondly, export prices converge to their new e:uilibrium level more :uic#ly than
domestic prices.
4oreign price increases also raise export prices and domestic prices, although the
coefficients are significantly higher than the expected coefficient of ). In the case of the
domestic price vector, this could reflect differences in the composition of the bundle of
goods used to construct the foreign and domestic producer price indices. In the export price
vector, export prices are unit value indices and not price indices, unli#e the foreign prices
used in the analysis. These foreign producer prices include non$traded goods and a better
relationship may emerge if an index of foreign tradable prices were used instead.
Figure +1: )onvergence to euilibrium of cointegrating vectors in response to a system
(ide shoc&
)ersistence )rofile of the effect of a s-ste#12ide shoc& to 3,4(s)
Pexp&r/ 2$V13
X-upp0: 2$V23
P,&6e-/ic 2$V33
%&ri'&(
0.0
0.2
0.4
0.6
0.8
1.0
0 5 10 15 20 25 30 35 40 45 50
4oreign real G23 raises export prices, but the coefficient '1.16( is also very high. Jnder the
small$country model, the coefficient on foreign income is expected to e:ual &ero. The
positive coefficient may be pic#ing up the positive impact of increased foreign demand on
export prices. As expected, foreign income does not affect export supply directly. 9owever
/)
increases in foreign G23 raise export prices, which in turn boosts export supply. xport
supply is thus indirectly boosted via the export price relationship. This relationship may
reflect the impact of global cyclical movements on South African export prices. This
positive association is consistent with estimated foreign income elasticities of export
demand in South Africa that range between ,.55 and )./. 'Smal, )**.Q Tsi#ata, )***Q
Golub, 1,,,Q Golub and 8eglows#i, 1,,1(.
!ising export prices relative to domestic prices raises the relative profitability of export
production and leads to an increase in supply of exports. As shown in Table )), the long$run
price elasticity of export supply is estimated to be ).)1. This is lower than the estimates for
developed countries reviewed in Goldstein and Aahn ')*-5= ),--( that ranged between ,.+
to )1.1. The estimated supply$price elasticity is also lower than the estimate for 9ong Aong
'5( by !iedel ')*--(, but is higher than those estimated for African countries by Ari&e
')*-+(. 7f the African countries studied 'Ivory 8oast, Tunisia, %orocco, %auritius,
%alawi, Yambia and Aenya( by Ari&e ')*-+(, only Aenya '1.6( and Yambia ',.**( had a
supply$price elasticity close to or in excess of ).
The long$run coefficient on domestic prices is negative '$,..1( showing that rising domestic
prices reduce export production. Goldstein and Aahn ')*-5( provide two explanations for
this relationship. 4irstly, rising domestic prices reduce the profitability of production for
export mar#ets relative to domestic mar#ets and hence cause a shift in resources out of
export production. Secondly, domestic prices serve as a proxy for production costs. !ising
domestic prices thus lower profitability of export production and hence reduce the :uantity
of exports supplied.
A ) 0 rise in unit labour costs reduce export production by ,.6. 0 in the long$run. !ising
unit labour costs can be caused by a decline in labour productivity and>or a rise in wages.
?ow productivity growth and>or excessive wage growth negatively affect export
profitability and thus export supply. The estimated negative association between unit labour
costs and exports is consistent with the study by dwards and Golub '1,,1( who analyse
unit labour costs in South African manufacturing vis$B$vis a range of developed and
developing countries.
The OownL error correction term for exports, ecm 1, is C,.+6 'see Table 6( reflecting a very
rapid convergence of a dise:uilibrium in the export supply relationship to e:uilibrium. A
positive dise:uilibrium in exports 'excess supply of exports( reduces next period export
supply such that +6 0 of the excess supply is removed. The rapid convergence towards
e:uilibrium is also shown in 4igure )/.
4urther insight on the short$run dynamics of export supply is provided by the error
correction e:uation for HI7? presented in Table )1 in Appendix 8. A rising trend in
domestic production 'G2393( is positively related to export growth. Goldstein and Aahn
')*+-( also find a positive relationship between domestic G23 and export supply for a
number of 782 countries. As found by Tsi#ata ')***( and dwards and Golub '1,,1(,
sanctions negatively affected export growth. Since )**/ export growth has accelerated, as
shown by the positive coefficient on FG!A, a dummy variable for the post$)**/ period.
The surge in exports since )**/ exceeds predictions on the basis of the time$series variables
in this analysis and could reflect structural changes associated with the end of Apartheid and
the new outward$oriented economic policies pursued. The growth, however, may only
/1
reflect a once off boost in export growth subse:uent to the ending of sanctions and the re$
integration of South Africa into the world economy.
7ne of the advantages of using the @ohansen %aximum ?i#elihood procedure for
multivariate cointegration analysis is that it allows for the estimation of e:uations in which
all variables are explicitly endogenous 'Swift, )**-(. 4urther, the short run dynamics of the
error correction model are also estimated within the system. It is thus possible to analyse the
effect of a shoc# to a particular variable on all the endogenous variables in the cointegrating
IA! model. This is particularly useful in the case of a shoc# to the exchange rate as the net
effect of a depreciation on exports depends on how it feeds into export prices, domestic
prices and wage increases.
4igure )5 displays the dynamic effects of a one unit 'measured as one standard error(
depreciation of the exchange rate on the endogenous variables in the model. The impact
effect 'concurrent period effect( is a rise in export prices and export supply. The immediate
impact on domestic prices and unit labour costs is close to &ero, but as the depreciation
feeds into the system, wages and domestic prices rise, reaching their pea# at around +
:uarters. The exchange rate also appreciates slightly from its initial shoc# and reverses the
rise in export prices experienced during the first / periods. xports rise sharply in the first
period subse:uent to the exchange rate depreciation, but decline rapidly relative to the initial
shoc# in the subse:uent periods as domestic price and wage increases erode export
profitability. xports stabilise after approximately + :uarters at a higher level than prior to
the depreciation. 9owever, the new level of exports is lower than it would have been if
wages and domestic prices had also not risen in response to the depreciation.
16

Figure +3: 'mpulse response to a shoc& in the exchange rate
Fote= "oth 33I47! and MSTA! are endogenous in this system. The foreign price declines slightly in
response to the exchange rate depreciation, but foreign income is not affected.
16
The impact effect 'effect in period ,( reflects the covariance between the exchange rate error and the error
in the export e:uation. An alternative to the generalised impulse response is the orthogonalised impulse
response whereby the e:uations in the system are adDusted to remove the correlation in the error terms. The
impact shoc# 'effect in period ,( is then reduced to &ero. The orthogonalised impulse response shows a rapid
increase in export supply during the first period, but declines in subse:uent periods and converges on close
to &ero by period .. This result suggests that the long$run impact of a depreciation on exports may be &ero.
/6
enerali!ed "#pulse $esponse(s) to one S%E% shoc& in the e'uation for E$A(E
XVOL
PX
ERAE
PP!"OM
#L$
%&ri'&(
-0.005
0.000
0.005
0.010
0.015
0.020
0.025
0.030
0 5 10 15 20 25 30
Three conclusions emerge from this analysis.
4irstly, the export supply response to exchange rate shoc#s will be exaggerated if
feedbac# effects of exchange rate changes onto domestic prices and wages are not
accounted for.
Secondly, the short$run export supply response to an exchange rate depreciation may
exceed the long$run response. This is because export prices rise :uic#ly in response to
an exchange rate depreciation, but domestic prices and wages respond more slowly.
2omestic price and wage increases negatively affect export supply.
Thirdly, a depreciation results in a net increase in the volume of exports supplied.
$.3 Import demand e"uations
The import demand e:uation : , was estimated for merchandise imports using :uarterly
and annual data. Import demand e:uations for manufacturing were also estimated, but only
using annual data over the period )*+, to 1,,). Given the very similar trends of
merchandise and manufacturing imports '4igure .(, the import demand e:uations are
expected to give similar results. Import supply is assumed infinite.
The variables used in the analysis are as follows=
%I7?= Iolume of merchandise imports, )**5E),,
%%AF= !eal manufacturing imports at )**5 prices
3I% 3JI= Jnit value import price, seasonally adDusted
3I% 33I= 3roducer price index of imported commodities
3%%AF= Import prices of manufacturing
33I27% P 3%27%= 2omestic producer price index for SA goods produced for local
consumption
G2%AT3= !eal gross domestic expenditure in mar#et prices
G23SA= South African real G23
TA!I44IF8= Tariff collection rates including surcharges
All variables are non$stationary and integrated of order one, i.e. I')(. 2ummy variables for
the sanction period, the post$)**/ period and the )*-/$-5 period were also included.
The long$run coefficients of the import demand e:uations are shown in Table / for
merchandise imports using :uarterly data and in Table 5 for merchandise and manufacturing
imports using annual data. The test statistics used to determine the number of cointegrating
vectors 'one in each case( are not discussed, but are presented in the data Appendix. 4or
brevity more emphasis will be placed on the :uarterly results.
The results of all estimates are consistent with theoretical expectations. Import demand is
shown to be highly responsive to changes in the price of imports relative to domestic prices.
In all estimates the restriction that the coefficients of the import prices and domestic prices
were e:ual, but opposite in sign could not be reDected, i.e. homogeneity is preserved. A ) 0
rise in import prices reduces import demand for manufacturing and merchandise goods by
).5* 0 to 1./6 0 in the long run. The latter estimate is obtained when using the producer
price index for all imported commodities obtained from Statistics South Africa 'Source=
3,)/1.)( rather than the unit value index obtained from the !eserve "an# Kuarterly
"ulletin. "ecause the bundle of commodities is not fixed in the unit value index, spurious
//
price indices may arise which can yield biased and inconsistent estimates 'Goldstein and
Aahn, )*-5= ),55Q Shiells, )**)(. The 33I based import price, included in the analysis to
test the sensitivity of the results, yielded higher estimates of the price elasticity of import
demand.
Table 1: >ong%run coefficients of merchandise import demand, uarterly data
9ependent variable
5erchandise imports
+68-+ ? -..+1
'mport unit
values
'mport producer
price index
G2%AT3 ).*).5 ).6*11
5A//C: 5A/0E*
TA!I44IF8 $,.161- ,
5A5CED
33I27% ).5*/* 1./6,)
5A/5/D 5A20CD
3I% 3JI $).5*/*
5A/5/D
3I% 33IT $1./6,)
5A20CD
cm Wp$valueX $,./,.- W,.,,,X $,.6+-/ W.,,,X
?! test of restrictions '
1
( Wp$valueX /..,51W./*+X 1.--6.W.16+X
IA! / /
Fote= In both estimates the restriction that the sum of the coefficients on 33I27% and Import prices e:ual
&ero 'i.e. ) N 1 E ,( could not be reDected.
Asymptotic standard errors are in italics below the coefficients.
All variables other than the import prices are exogenous in the estimates.
Table 3: >ong%run coefficients of merchandise and manufacturing import demand,
annual data
5erchandise imports 5anufacturing imports
)oef, )oef,
3%JI $).5-5- 3%27% $).-)66
5A20CD 5A/E:*
3%27% ).5-5- 3%%AF ).-)66
5A20CD 5A/E:*
G23SA )..*.1 G23SA ).+/5-
5A0B:B 5A050E
cm Wp$valueX $,.6.5- W.,,,X $,.5++1 W.,,,X
?! Test 1.1/,5 W.)6/X ,.)1)1 W.+1-X
IA! ) 1
Time period )*+,$1,,) )*+,$1,,)
Fotes= The tariff variable was not significant and was omitted from the regressions to preserve degrees of
freedom.
In both estimates the restriction that the sum of the coefficients on domestic prices and import prices e:ual
&ero 'i.e. ) N 1 E ,( could not be reDected.
G23SA was used rather than gross domestic expenditure as the latter yielded counterintuitive or insignificant
results.
Asymptotic standard errors are in italics below the coefficients.
G23SA is exogenous in the %erchandise estimates. 3rice of imports and G23SA are exogenous in the
manufacturing estimates.
The estimated price elasticity of import demand is substantially higher 'in absolute value(
than the ,.-5 and ).,5 estimated by Smal ')**.( and SenhadDi ')**+(, respectively. The
/5
estimates also fall in the top end of the estimates of developed countries reviewed by
Goldstein and Aahn ')*-5(. The elasticities, however, are similar to those estimated for
%auritius, %alawi and Tunisia by Ari&e ')*-+(.
Gross domestic expenditure and G23 positively affect import demand and reflect the very
high intermediate and capital goods content of South African imports. The income
elasticities show that a ) 0 increase in G23 or gross domestic expenditure raises total
imports of manufacturing and merchandise goods by ).6* 0 to ).*1 0 in the long$run.
Tariff rates, calculated as the ratio of collection duties plus surcharges to the value of
merchandise imports, reduce import demand 'coefficient E ,.16(, but only in the estimate
using :uarterly data for merchandise imports. Golub '1,,,( found similar results.
The infinite supply of imported products imposed on the model implies a full pass$through
of a depreciation onto import prices measured in South African !ands. To analyse the
dynamic effects of a shoc# in the price of imports, 4igure ). presents the impulse response
of a one standard error shoc# in import prices '3% JI( on the endogenous variables within
the system. 4urther information on the short$run dynamics is also provided in the error
correction e:uations for imports presented in Table )- and Table 1, in Appendix 8.
7f main interest to this study is the response of import demand to the shoc# in import
prices. The impact effect>concurrent effect is a decline in import demand, which arises from
the negative covariance between the errors of the import volume and import price e:uations.
In the subse:uent period imports rise sharply, possibly in response to hoarding behaviour of
importers in the face of a currency depreciation. This positive short run effect is also shown
in the positive coefficients on the lagged variables for the change in import prices 'Table )-
and Table 1,(. Imports only fall sharply in period /. Import prices also feed into domestic
prices, but slowly. Gross domestic expenditure also declines slightly as rising import prices
negatively affect expenditure, production and investment.
Figure +7: 'mpulse response to a shoc& in import prices
Fote= All variables are endogenous in the system. In the results presented in Table /, all variables other than
%I7? are exogenous.
/.
enerali!ed "#pulse $esponse(s) to one S%E% shoc& in the e'uation for )"*)+,
MVOL
)"EM*P
PP!"OM
P!MP#V
%&ri'&(
-0.01
-0.02
-0.03
-0.04
0.00
0.01
0.02
0.03
0.04
0 5 10 15 20 25 30
8, )onclusion and policy suggestions
The obDective of this study is to assess the impact of exchange rate movements on the South
African trade balance. In particular, the study assesses whether a depreciation of the
currency will improve the trade balance through promoting export production and import
substitution? This relationship is of central importance to the GA! macroeconomic
strategy, which aims to improve export growth through maintaining a stable and competitive
real effective exchange rate.
The study follows much international empirical research and uses the elasticity approach to
analyse the responsiveness of exports and imports to exchange rate movements. The study
draws upon the "ic#erdi#e$!obinson$%et&ler '"!%( condition which defines a set of
necessary conditions on the si&e of import demand, import supply, export demand and
export supply elasticities for a depreciation to improve the trade balance. "ecause of
limitations with this approach, additional relationships, such as the feedbac# of a
depreciation into domestic inflation, are also incorporated into the analysis
The study finds that export and imports remained relatively stable during the )*+,s and
early )*-,s, but grew strongly from the mid$)*-,s. xport growth was particularly strong
within manufacturing which has become the dominant source of export revenue, accounting
for ./ 0 of total exports 'excluding services( in 1,,,. Indicators of openness 'exports and
imports as a share of G23, import penetration and export orientation( have also risen
sharply, reflecting the rising importance of international trade for the domestic economy.
4or example, manufacturing exports as a share of output grew from ),.1 0 in )*-5 to 1+.5
0 in 1,,,. Similarly, strong growth in imports raised import penetration 'imports as a share
of consumption( from )- 0 in )**, to 61 0 in 1,,,.
The manufacturing trade balance has also improved during this period. In contrast, the
merchandise trade balance worsened which largely reflects the decline in gold exports. The
improvement in the manufacturing trade balance since the mid$)*-,s coincides with a
depreciation of the domestic currency. 9owever, this does not necessarily imply a causal
relationship as numerous other policy changes occurred during this period. 4or example, the
Generalised xport Incentive Scheme 'GIS( subsidised export production during the early
)**,s. Trade liberalisation, which accelerated from )**/, has substantially improved the
profitability of export production by reducing the cost of domestic and imported
intermediate goods used in the production process. 4inally, the ending of sanctions and the
re$integration of South Africa into the international mar#et have further enhanced export
performance.
In its interaction with the international mar#et for non$gold merchandise products, South
Africa behaves li#e a small country and prices according to international prices, i.e. South
Africa is on average a price$ta#er. This is shown in the close relationship between exchange
rate movements and export prices of non$gold merchandise goods. xport prices rise by the
full depreciation of the currency. As a result, South African export prices have not declined
relative to foreign export prices during the )**,s, despite the depreciation of the currency.
xport growth thus appears to be driven by changes in the profitability of export supply,
rather than lower foreign currency denominated prices of South African exports, particularly
during the )**,s.
/+
The implication is that a depreciation of the currency can improve export performance, not
through lowering the foreign currency price of South African exports, but through raising
the return to export production via increased prices. 9owever, the graphical analysis also
shows that the improved profitability of export production is fre:uently eroded by domestic
inflation and wage increases. 4or example, no long$run deviation between the exchange
rate, export prices and domestic prices is found. As a result, no sustained relationship
between exchange rate movements and the trade balance is shown in the diagrams.
The econometric estimates of the export and import functions support these conclusions, but
overall suggest that a depreciation improves the trade balance. The long$run export supply
elasticities range between $).,5 and $).)1 are similar for manufacturing and merchandise
goods 'excluding gold(. 9olding all other variables constant, this implies that a depreciation
raises exports by ).,5 to ).)1 0 in the long run. The long$run import demand elasticities
range between $).5* and $1./6, which also show that a depreciation, holding other variables
constant, reduce imports substantially. These estimates exceed those of other South African
studies that range between C,.-5 and C).)5 'Aahn, )*-+, Smal, )**. and SenhadDi, )**+(.
Given the estimated elasticities, the elasticity of the trade balance 'normalised by the value
of imports( with respect to a currency depreciation 'E
!
( can be calculated. The appropriate
"!% condition for a depreciation to improve the trade balance in a small country is given
by
, > "# $%
#
%
! E E
'
'
E
.
Substituting the long$run export supply elasticity ').)16( and the import demand elasticity '$
).5*( for merchandise goods into this relationship gives a long$run exchange rate elasticity
of the trade balance e:ual to 1.+)6. This implies that a ) 0 depreciation improves the trade
balance of non$gold merchandise goods by 1.+)6 0 of the value of imports in the long run.
The elasticity for manufacturing is similar at 1.*-6. The improvement in the trade balance in
response to a depreciation is consistent with the conclusion reached by Smal ')**.(.
9owever, the impact estimated using the "!% condition exaggerates the impact of a
depreciation on the trade balance as it does not ta#e into account the feedbac# into domestic
prices, nor the dynamics surrounding the convergence to e:uilibrium in response to an
exchange rate shoc#. An advantage of the @ohansen %aximum ?i#elihood procedure for
multivariate cointegration analysis used in this study, is that it allows for the endogeneity of
all variables included in the regressions. The regression results indicate that both domestic
and export prices are strongly influenced by changes in the exchange rate. A ), 0
depreciation raises export prices and domestic prices by *.1 0 and -.). 0 in the long run,
respectively. The rise in inflation thus negates much of the improved profitability of export
production arising from a depreciation of the currency. Gage costs are also shown to
increase with a depreciation, further reducing the relative profitability of export production.
Although short$run elasticities are not calculated, the dynamics surrounding the adDustment
towards e:uilibrium in response to an exchange rate shoc# are assessed using impulse
response functions. xport prices are found to converge more rapidly to e:uilibrium '. to +
:uarters(, compared to domestic prices '). :uarters(. As a conse:uence, exports rise
:uic#ly, but then decline from their pea# as domestic prices and wages rise. :uilibrium is
reached after - :uarters. Imports tend to respond more slowly and only show a significant
decline after / periods. The South African trade balance may thus exhibit the @$curve effect,
with the trade balance initially deteriorating, then improving in the long run.
/-
Several policy conclusions emerge from this study.
xport growth is primarily driven by increases in export supply. xport prices rise :uic#ly
in response to a depreciation rate and the pass$through of the exchange rate to destination$
currency prices is close to &ero. xporters, on average, are price$ta#ers in the international
mar#et and do not compete for mar#et share on the basis of price. This does not imply that
foreign prices are unimportant. 4oreign price increases raise the profitability of export
production and thereby induce increases in the :uantity of exports supplied.
This conclusion suggests that export growth responds positively to improved profitability of
export production. A depreciation of the currency is one such avenue to achieve this.
9owever, the results of this analysis suggest that a depreciation of the currency is not
necessarily the optimal approach to improve export performance. A depreciation of the
currency raises profitability of export production, but the increased profitability, and hence
export supply, is only sustainable if domestic price and wage increases do not offset these
gains. If wages and domestic prices rise, as historical evidence suggests it does, further
depreciation of the currency will be re:uired to maintain increases in export growth. This
may lead to an inflation spiral.
A more important policy obDective is to reduce the volatility of the exchange rate. "ecause
South African exporters are price$ta#ers, exchange rate volatility translates directly into
profit volatility. This volatility has also been shown in the profitability index shown in
4igure *. Iolatility of profits increases the ris# associated with export production,
particularly for small businesses that do not have sufficient finances to hedge themselves
against this ris#. Jsing a national firm survey of South African manufacturing firms,
dwards '1,,1( finds that only 1- 0 of small firms export compared to +, 0 of large firms.
Similar values are found by 8handra et al. '1,,)( for the Greater @ohannesburg
%etropolitan Area. The entrance of small firms into the export mar#et is an important
obDective to increase South African export growth. Stable profits enabled by a stable
currency may encourage entrance of small firms into the export mar#et.
The impact of a depreciation and appreciation are not necessarily symmetrical and are
influenced by institutional structures that induce rigidities into the adDustment of wages and
domestic prices. 4or example, if wage and domestic price rise :uic#ly in response to a
depreciation, the gains to the trade balance will be short lived. In contrast, if wages and
prices are rigid downwards, an appreciation of the currency may lead to a sustained deficit
in the trade balance. 8urrent trends in domestic inflation suggest that prices have been slow
to adDust downwards in response to the appreciation of the currency from mid$1,,1. South
African exporters have thus faced falling export prices 'in !ands( combined with continued
increases in their costs of production. These trends compound one another leading to
significant reductions in export production. The strong currency will thus have a severe
negative impact on the trade balance.
8an a depreciation of the currency be used to offset high domestic production costs,
including labour costs, that inhibit export growth? dwards and Golub '1,,1( show that a
depreciation positively boosts exports by reducing South African wages relative to other
country wages measured in a common currency. 9owever, improving labour cost
competitiveness through depreciation is not sustainable in the long run. 2epreciation of the
currency reduces the real wage of wor#ers, who then bargain for compensatory wage
/*
increases. dwards and Golub '1,,1( show that the depreciation of the South African !and
vis$B$vis other developing country currencies during the )**,s failed to offset wage
increases in many industrial sectors.
Alternative approaches towards increasing export performance and competitiveness of
import competing firms need to be found. 3rofitability of export production can be
improved through enhanced productivity growth combined with wage moderation. dwards
and Golub '1,,1( show that both wages and productivity are important determinants of
export growth. This study also finds that high unit labour costs, arising from low labour
productivity and>or high wages, negatively affect export supply. 3olicy that encourages
productivity improvements combined with wage moderation will thus enhance export
growth.
There are a number of approaches to improving productivity growth. 4irstly, improvements
in education, particularly the :uality thereof, are essential long$run policy obDectives
necessary to raise the productivity of South AfricaLs labour force. In addition to enabling
real wage increase, productivity improvements will enhance South AfricaLs export
performance.
Increased investment in new technology and productive capacity is a further avenue through
which to improve labour productivity. Increased investment in new technology can be
encouraged through an accelerated program of tariff liberalisation. This lowers the cost of
access to foreign technology as well as induces productivity gains through increased
international competition. Gor# by @onsson and Subramanian '1,,,( has shown a positive
relationship between improved T43 growth and trade liberalisation. Ian Seventer '1,,)(
also notes that the reduction in tariff rates has substantially reduced the anti$export bias
arising from protection on intermediate goods used in the production process. ?ower
production costs and improved productivity will also increase entry of firms into the export
mar#et, and thus further enhance the diversification of exports shown by "lac# and Aahn
')**-(. Although it is feared that tariff liberalisation will negatively affect employment,
dwards '1,,)a( shows that employment creation through improved export growth
compensates for employment lost in import competing sectors.
:, Appendix A: Econometric methodology
(.1 Econometric methodolo)y
The @ohansen %aximum ?i#elihood procedure for multivariate cointegration analysis was
used '@ohansen, )*--, )**1(. This approach is appropriate as it allows for the estimation of
a system of e:uations in which all variables are endogenous '@ohansen and @uselius, )**,(.
The data generating process is assumed to be represented as a p order vector autoregressive
model
E .: t t p t p t t
" F ! F ! F + + + + +

...
) )
( , , ' niid is Q ,..., )
t
, t
where F
t
is the #) vector of stochastic I')( variables and "
t
is a vector of non$stochastic
I',(variables and
t
denotes a white noise process.. The non$stochastic variables include
dummies for the sanction period ')*-.$)**1( and the post )**/ period. Seasonal dummies
can also be included. The system can be reparameterised as an error correction model
'8%(
5,
E .:
t t
p
i
i t i t t
" F F F + + + +

)
)
)
where is a =x= long run multiplier matrix,
i
are coefficient matrices capturing the short$
run dynamic effects, is the matrix of coefficients on the I',( exogenous variables. If there
are no cointegrating relationships then E , and ')( represents a stationary IA! for &
t

'Ierbee#, 1,,,(. If there exists r cointegrating relations between the I')( variables, there are
r combinations of F
t
that are stationary, i.e. I',(, and the ran# of is r. The matrix can
then be represented as

where is a =xr matrix and ) is a rx= matrix, both of ran# r. The rows of matrix ) form
the r cointegrating vectors and the coefficients of the error correction term. This reflects
the speed of adDustment towards e:uilibrium. Substituting this into '1( we obtain
E .:
t t
p
i
i t i t t
" F F F + + + +

)
)
)
Z
where )F
t>*
represents the cointegrating relationships and measure the adDustment of &
t

to the r e:uilibrium errors 'y
t
E )F
t>*
( 'Ierbee#, 1,,,(.
If the &
t
variables contain deterministic trends 'as shown in the A24 tests(, and these are not
restricted, the variables will be determined by m>r :uadratric trends. Fo :uadratic trends are
evident in the data and the trends, when included, are restricted into the cointegrating
vectors
E .:
t t
p
i
i t i t t
" F t F F + + + +

)
)
)
( ' Z
where t is a time trend and is a vector of fixed constants. If ) , then the there are linear
trends in the cointegrating relationships '3esaran and 3esaran, )**+(. The I8% '6( can
further be generalised where some variables x
t
in the vector &
t
are treated as structurally
exogenous in that there are no error correction feedbac#s in the e:uations explaining x
t

'3esaran and 3esaran, )**+= /6,(. Ghen variables were found to be wea#ly exogenous, the
system was re$estimated with the relevant error correction terms restricted to &ero as
outlined in 3esaran and 3esaran ')**+(.
1/

The presence of cointegration is indicated by the ran# of . The @ohansen procedure
involves the calculation of the set of = eigenvalues '
i
(, which provide a set of eigenvectors
that form the maximum li#elihood estimate of matrix . Two tests, the Trace statistic and
the maximal eigenvalue 'max( statistic, are used to test the significance of the eigenvalues
to determine the number of cointegrating vectors 'r( within . The number of suggested
cointegrating vectors often differed across the two test statistics. In these cases the number
of cointegrating vectors was selected on the basis of economic theory.
In order to lin# the cointegrating vectors to a particular economically meaningful structural
e:uation, it is necessary to impose identifying restrictions on the coefficients within each
vector. If there are r cointegrating vectors, exact identification re:uires r independent
1/
8ontemporaneous and short term feedbac#s from &t to xt are permitted, but no such feedbac#s are permitted
in the long$run.
5)
restrictions on each cointegrating vector, one of which will be the normalisation restriction.
4or example, in the case of the export functions two cointegrating relationships are
expected= one for supply and one for demand. Jsing the model in e:uation ')a$)c(, but with
PxS separated into Px and the exchange rate 'erate( and excluding lprod, the long$run
parameters can be represented as=
15
)
1+ 1. 15 1/ 16 11 1)
)+ ). )5 )/ )6 )1 ))
+1 +)
.1 .)
51 5)
/1 /)
61 6)
11 1)
)1 ))
)
S
S

1
1
1
1
1
1
1
1
1
]
1

1
]
1

1
1
1
1
1
1
1
1
1
]
1

t
t
7
w
P
P
erate
Px
%
F









9owever, in order to identify the supply and demand functions it is necessary to impose
restrictions on the various
iG
Ls. 4or exact$identification r
1
restrictions 'i.e. /( need to be
imposed. 2rawing on economic theory, further over$identifying restrictions can be imposed
to obtain a more complete structural representation of the export demand and supply
functions. A typical set of over$identifying restrictions imposed can be represented as
[ ]
)
1. 15 1)
)+ )/ )6 )1
)
S
S
, , , )
, , )

1
1
1
1
1
1
1
1
1
]
1

1
]
1

t
t
7
w
P
P
erate
Px
%
F


.
The log$li#elihood ratio test is used to test the restrictions. If the null hypothesis can not be
reDected, the first row of represents the export demand function, while the second row
represents the export supply. The supply function has been constructed such that Px is the
dependent variable.
1.
The elasticity of supply is thus C)>
1)
. An alternative approach is to
normalise the export demand function on Px. This is the approach followed by !iedel
15
This useful representation of the long$run relationship was obtained by %ariotti '1,,)(.
51
')*--( and is appropriate in the small country case where Px tends towards minus infinity.
9omogeneity restrictions can also be imposed. 7n the export demand side the
responsiveness to export prices measured in foreign currency '
)1
$
)6
( is expected to e:ual
the responsiveness to foreign price changes '
)/
(. 7n the export supply e:uation
homogeneity implies that
11
'E)( N
15
N
1.
E ,.
"ecause we impose an infinite supply of imports, the long$run import demand e:uation,
with the normalisation restriction
))
E ) imposed, can be represented as
[ ]
)
)/ )6 )1
)/
)6
)1
))
)
>
)

1
1
1
1
]
1

1
1
1
1
]
1

t
t
tariff
7
Pd Pm
#
F

4urther restrictions on the adDustment terms can also be imposed to test for the exogeneity
of any variable. 4or example, foreign MS is expected to be exogenous in the export demand
and supply e:uations, implying that dise:uilibrium in domestic export supply or demand do
not feedbac# into changes in foreign income. In this case
E*
and
E/
are expected to e:ual
&ero.
(.2 Estimation procedure
The following strategy was followed in the estimation of the I8% models=
). The Augmented 2ic#y 4uller 'A24( test is used to test whether all variables are
integrated of order one, I')(. Ghen trends in the data were evident the A24 test
including a drift components and trend term was utilised. A one sided test of the null
hypothesis of a unit root against the alternative of stationarity is used, i.e. 9,= E )
against 9)= V ). The minimum lag length consistent with no serial correlation in the
residuals 'tested using the ?agrange$%ultiplier test( determined the order of the A!
process. The A#ai#e information criterion 'AI8( and the Schwar& "ayesian criterion
'S"8( were also utilised in the selection of the lag length. The test statistics for the
:uarterly and annual data are provided in Table * and Table ),, respectively.
1. The @ohansen procedure is sensitive to lag length and the inclusion of deterministic
trends and>or constants. The lag length of the vector autoregressive 'IA!( model was
selected using the A#ai#e information criterion 'AI8( and the Schwar& "ayesian
criterion 'S"8(, subDect to the absence of serial correlation 'tested using the ?agrange$
%ultiplier test( in the individual IA! e:uations. In many cases it was not possible to
select a lag length that removed serial correlation in all e:uations, and often
heteros#edasticity and non$normality of the errors remained. Alternative variables,
including dummy variables, were then included to account for these problems.
Fevertheless, many of these problems persisted. The selection of the order of the IA!
is thus subDect to an important degree of uncertainty.
6. The Trace statistic and the maximal eigenvalue 'max( statistic are used to determine
the cointegrating ran#, i.e. the number of cointegrating vectors. The number of
suggested cointegrating vectors often differed across the two test statistics. In these
cases the number of cointegrating vectors was selected on the basis of economic theory.
1.
The elasticity of supply is thus C)>1). !iedel ')*--( normalises the export demand function on Px. This is
appropriate in the small country case where Px tends towards minus infinity.
56
/. @ust$identifying and over$identifying restrictions are imposed according to the
specification of the export and import demand and>or supply functions. The over$
identifying restrictions were tested using a log$li#elihood ratio '?!( test statistic that has
a chi$s:uared distribution with degrees of freedom e:ual to the number of over$
identifying restrictions '3atterson, 1,,,= ./)(.
5/
6, Appendix !: Additional results
*.1 #ther results
xport functions were also estimated for manufacturing goods using :uarterly data and
merchandise goods 'excluding gold( using annual data. The results for most models were
poor. In all estimates the export demand e:uation was normalised on 3H, as outlined in :
,. The small country hypothesis that the coefficient on 3H e:ualled &ero was then tested. In
most cases this restriction could not be reDected, but the sign of the coefficient was incorrect.
In the analysis that follows, two sets of results, one each for manufacturing and merchandise
trade, are briefly discussed.
The variables used in the analysis include annual versions of those used in the :uarterly
analysis. In addition, the following variables were utilised, particularly in the manufacturing
estimates=
H%TI3S= %anufacturing exports in )**5 prices
3H%TI3S= %anufacturing export price
G23SA= !eal gross domestic product for SA
%anufacturing export data over a long time period was difficult to obtain. Two data sources
have been used. Kuarterly export volume and price data were obtained from Statistics South
Africa for the period )*+5 to the end of )*-+. The SSA data were spliced to data obtained
from the Trade and Industrial 3olicy Strategies for the period )*-- to the end of 1,,,.
These data sets use different approaches in constructing the export volume and price data. In
addition, the Statistics South Africa data was not available for a common base year. The
series for different base years were therefore merged together. 2istortions in the data
induced in the process of merging the data sources may account for the poor results obtained
for manufacturing.
Table . presents the estimated long$run relationships for each cointegrating vector using
annual data for non$gold merchandise exports over the period )*5, to 1,,). The maximal
eigenvalue and trace tests statistics suggested 1 and 6 cointegrating vectors, respectively
'see Table )6(. Formalising restrictions were imposed on 3H, HI7? and G23SA as
alternative restrictions did not yield sensible results.
1+
The first cointegrating vector
represents the export demand e:uation : ,, the second represents export supply and the
third a function for SA G23. Two additional Dust$identifying restrictions were imposed on
each vector in accordance with the functional form of the export demand and supply
functions.
The results are similar to those for merchandise trade estimated using :uarterly data. The
cointegrating vector normalised on export prices shows that export prices rise by -) 0 of
the exchange rate depreciation. 4oreign price increases also raise domestic export prices, but
as in the earlier result the coefficient of ).* is excessively high. Increases in foreign income
lower export prices, which is unexpected and contradicts the :uarterly results.
1+
The vector was also normalised on the exchange rate and domestic prices, but these did not yield
interpretable results.
55
Table 7: Estimated export demand and supply functions for SA merchandise exports,
annual data +63.%-..+,
;ust%identified restrictions <ver%identified restrictions
9ependent variable P=@4 =4<> "9PSA P=@4 =4<> "9PSA
)4 + )4 - )4 / )4 + )4 - )4 /
HI7? ,.)+6, ,.61*, , ,.1.1-
5A*0:D 5A*E02 5A*/2B
3H ,.*,-+ , ).,5/) ,
5A0/:0 5A0:2/
33I27% , $,.+55+ $,.,)/6 , $,.--/- $,.)*+-
5A25E* 5A5B0D 5A0EC0 5A522:
G23SA , ).)/5. , ).11.-
5A*EDE 5A*0DB
!AT ,.*56, , $,.16,5 ,.-,*+ , ,
5A52*D 5A**/0 5A5CDE
33I47! ).6*/- ,.,.6) , ).*6)* , ,
5A5DE: 5A2E*E 5A*B2*
MSTA! $,..*-. , ,.-1+* $,..)/- , ,.-*+1
5A*C20 5A///B 5A//CC 5A*DCB
cm)'$)( Wp$valueX $,./6* W.)*,X
cm1'$)( Wp$valueX $,.6/+ W.,*,X
cm6'$)( Wp$valueX $,..// W.1/1X
?! test of restrictions '
1
( Wp$valueX 5..*-+W,.)1+X
IA! 1
Fote= Asymptotic standard errors are in italics below the coefficients.
The signs of the coefficients in the G23 relationship are of the expected signs. Inflation
negatively affects G23 and export growth positively affects G23. 4oreign G23 has the
strongest impact with South African G23 closely following international trends.
7f primary interest to this study is the export supply e:uation. As in the earlier estimates,
G23 positively affects export supply with a long$coefficient of ).16. The price elasticity of
export supply is estimated at ).,5 and is similar to the ).)1 estimated using :uarterly data.
2omestic prices reduce the relative 'and absolute( profitability of export production and
hence negatively affect export supply.
Table + presents the long$run coefficients for the cointegrating relationships estimated using
manufacturing data. The maximal eigenvalue and trace tests statistics both suggested /
cointegrating vectors 'Table )5(. Formalisation restrictions were imposed on export prices
'3H%TI3S(, export supply 'HI7?(, the exchange rate '!AT( and domestic prices
'33I27%(. An additional 6 Dust$identifying restrictions were imposed to identify the
system. 4urther over$identifying restrictions were imposed in accordance with economic
theory.
The relationships determining export prices and domestic prices are similar to the earlier
estimates. An exchange rate depreciation raises export and import prices, but the former
more significantly than the latter. As found in the annual estimates, foreign income
unexpectedly negatively affects export prices.
5.
Table 8: Estimated export functions for SA manufacturing exports, uarterly data
+687+%-..+1,
9ependent variable Pexport =supply Erate Pdomestic
)4 + )4 - )4 / )4 1
H%TI3 , , ,
3H%TI3S ).)1/* , ,
5A2D:5
!AT ).,,,, , ,..5.)
5A*5/B
33I27% , $).)1/* ).*11+
5A2D:5 5AE/DC
33I47! ).1-+6 , $6.+,1, ).-*)+
5A/*E: 5ADCE0 5A/E*B
MSTA! $).151- , $1.-+-/ ,
5A/C/* /AB/*5
J?8 , , , ,.).+/
5A5BEC
ecm)'$)( $,.)++5 W.,/1X $,.+,6. W.,,6X ,.))+- W.)*/X ,.,56+ W.,,/X
ecm1'$)( ,.,16* W.5)6X $,.//.+ W.,,,X $,.,1/+ W.5)*X ,.,,,/ W.*.6X
ecm6'$)( ,.)1.6 W.)**X ,..*/- W.,,*X $,.,6.1 W.+1/X ,.,6// W.,**X
ecm/'$)( ,.1/16 W.1++X )..**1 W.,,5X $,.))-+ W..),X $,.,-,- W.,--X
?! test of restrictions '
1
( Wp$valueX 5.6.)1 W.)/+X
IA! )
Fote= Serial correlation in the unrestricted IA! e:uations for 33I27%, 33I47! and J?8. The sum of the
coefficients on 33I27% and 3H are restricted to e:ual &ero. As part of the initial Dust$identifying
restrictions, the coefficient on !AT was set e:ual to one, i.e. the small country assumption was imposed.
Asymptotic standard errors are in italics below the coefficients.
In accordance with the 333 relationship, foreign price increases and domestic price declines
cause an appreciation of the currency. 9owever, the coefficients are unrealistically large.
The strange results for foreign income and the large coefficients within the exchange rate
e:uation probably reflect the failure to satisfy the conditions of normally distributed error
terms with no heteroscadasticity and serial correlation re:uired for the determination of the
number of cointegrating relationships. The results in this section need to be treated with
caution.
The results for the export supply relationship are consistent with theory and indicate a price
elasticity of supply e:ual to ).)1. The homogeneity restriction that the coefficients of the
export price and domestic price are e:ual, but opposite in sign could not be reDected. The
error correction term 'ecm1( for the export supply e:uation e:ualled C ,./5 and shows a
rapid adDustment towards e:uilibrium.
5+
+., Appendix ): Tables
1+.1 ,election of countries and -ei)hts
Table :: Selection of countries and (eights used in the analysis
)ountries
Aeights
rerppi, rercpi,
ppifor
rerxuv erate
Jnited States )..60 )*..0 )+..0
Jnited Aingdom )5./0 )-..0 )...0
4rance /.,0 ,.,0 /.60
Germany )+.10 1,..0 )-.50
Italy 5.10 ..60 5.+0
Fetherlands /.60 5.)0 /..0
Swit&erland 5.50 ,.,0 5.*0
8anada )./0 ).+0 ).50
@apan )6.10 )5.-0 )/.10
Spain 1.,0 1./0 1.)0
Tur#ey ,.50 ,.,0 ,.,0
Australia 1..0 6.)0 1.-0
"ra&il ).50 ).*0 ,.,0
8hile ,./0 ,.,0 ,.,0
Israel ).+0 1.,0 ,.,0
India ).10 ).50 ).60
Aorea 6.,0 ,.,0 ,.,0
Singapore 1.,0 ,.,0 1.10
Thailand ).10 )./0 ).60
Aenya ,.+0 ,.,0 ,.-0
%auritius ,..0 ,.,0 ,.+0
Total +..,.B +..,.B +..,.B
1+.2 .nit roots tests
Table 6: @nit root test statistics for uarterly data
>evel First difference
Figure trend A9F test >ag length Figure trend A9F >ag length
!!HJI 2ownward $6.)5-1 1 'AI8, ?%( I')( Stationary $),.*)1) ) 'AI8,S"8(
!!83I 2ownward $1./*)/ 1 'AI8, ?%(
)'S"8(
I')( Stationary $*.-1-- ) 'AI8,S"8(
!!33I 2ownward $1..55+ 1 'AI8, ?%( I')( Stationary $),.5*)/ ) 'AI8,S"8(
MSTA! Jpward $1.**). 1 '?%(, 6
'AI8(
1
I')( $/.,--, 1 'AI8(
3HJI327% Fo trend $).5-+1 1 '?%(, )
'AI8(
I')( $)6.6*)- , 'AI8(
8J Slight downward $/.-*1- . '?%( I',(
J?8 Jpward $.1+1*/ 6 'AI8(, 1
'S"8, ?%(
I')( $5./*.1 1 'AI8(
G2%AT3 Jpward $1.,*.- ) '?%, AI8( I')( $5..)*, ) 'AI8(
HI7? Jpward
5
$1....) ) '?%, S"8( I')( $*.,/,* 1 'AI8(
HIA?SA Jpward $)..55- 1 '?%, S"8,
AI8(
I')( $)1.,*./ 1 'S"8, AI8(
%I7? Fo trend 'except
in *,s(
)
$).6.+5 / '?%, S"8,
AI8(
I')( $)6.+5,* , 'AI8, S"8(
%IA?SA Fo trend 'except
in *,s(
+
$).*/,) ) 'AI8( I')( $)6.),.1 , 'AI8, S"8(
TA!I44IF8? Fo trend $).1-/* / '?%, AI8,
S"8(
I')( $5.5+5. 6 'S"8, AI8(
H%TI3 Jpward $).)1-) 6 '?%( I')( $-.)/*1 1 'AI8, S"8(
5-
3H%TI3S
Jpward $1.6-,, / '?%, AI8,
S"8(
I')( $/.1.,, / 'AI8, S"8(
33I27% P
3%27%
Jpward $.15.6/ / 'AI8( I')(
G23SA Jpward $1.)/)- / 'AI8( )
'S"8(
I')( $5..+*1 ) 'AI8(
G2393 Jpward $1.5/+5 I')(
MSTA! Jpward $6.1/5, 6'AI8( $+.5*56 ) 'S"8, AI8(
!AT Jpward $).*++) 6 'AI8, S"8( I')( $5.11/) 1 'AI8, S"8(
3I%JI Jpward $).+/1, ) 'AI8, S"8( I')( $)6./+., , 'S"8, AI8(
3I%33IT Jpward $).).+1 / 'AI8, S"8( I')( $+..1)- , 'S"8, AI8(
33I47! Jpward $).-+)) I')( $6.66*1 , 'S"8, AI8(
Fotes= The *5 0 critical values are $1.--.5 for the A24 test with drift and $6.//*) for the A24 including a
drift and trend component. 4or the series covering )*+5:) C 1,,,:/ the relevant statistics are $1.-*,. and
$6./551.
Table +.: @nit root tests using annual data
Figure
trend
A9F test >ag
length
)ritical
value
Mstar., Geighted foreign
G23
Jpward $)./1-5 ) 'AI8( $6.5-.+
xvol %erchandise
export volume
'excl gold(
Jpward $1.),,6 1 'AI8( $6.5-.+
%man %anufacturing real
imports
Jpward $1.6))1 , 'AI8,
S"8(
$6.5-.+
3mman %anufacturing
import price
Jpward $1.6+.5 , 'AI8,
S"8(
$6.5-.+
1+.3 &erchandise exports usin) "uarterly data' 1*/1"4 0 2++1"4
Table ++: Test statistics for cointegrating ran&, merchandise exports using uarterly
data, +68+1 to -..+1
Maximal eigenvalue test
*******************************************************************************
Null Alternative Statistic 95% Critical Value 90% Critical Value
r = 0 r = 1 94.2633 46.9700 44.0100
r<= 1 r = 2 76.7994 40.900 37.9200
r<= 2 r = 3 33.6704 34.7000 32.1200
r<= 3 r = 4 22.122 2.7200 26.1000
r<= 4 r = 5 19.30 22.1600 19.7900
r<= 5 r = 6 5.4243 15.4400 13.3100
*******************************************************************************
Trace test
*******************************************************************************
Null Alternative Statistic 95% Critical Value 90% Critical Value
r = 0 r!= 1 252.1776 12.7900 123.3300
r<= 1 r!= 2 157.9142 97.300 93.1300
r<= 2 r>= 3 81.1149 72.1000 68.0400
r<= 3 r!= 4 47.4445 49.3600 46.0000
r<= 4 r!= 5 25.2623 30.7700 27.9600
r<= 5 r = 6 5.4243 15.4400 13.3100
*******************************************************************************
N"tes# $ist "% ei&envalues in 'escen'in& "r'er#
.54115 .46991 .24291 .16750 .15122 .04339 .0000
()e %"ll"*in& e+"&en"us ,-0. an' 'u//0 varia1les *ere inclu'e'#
234546 SANC(,7N6 N898:A6 373;16 375;46 34;3;46 36;16 35;3;46 36;46 396;26 39;36 301;4
an' centre' seas"nal 'u//ies.
<S(A: is *ea=l0 e+"&en"us
5*
Table +-: E)5 of export supply for merchandise goods, uarterly data
EM %"r varia1le !"#$ esti/ate' 10 7$S 1ase' "n c"inte&ratin& VA:-2.
*******************************************************************************
3e>en'ent varia1le is '?V7$
121 "1servati"ns use' %"r esti/ati"n %r"/ 1971;4 t" 2001;4
*******************************************************************************
:e&ress"r C"e%%icient Stan'ar' 8rr"r (@:ati"A4r"1B
,nterce>t @9.9974 5.225 @1.9121A.059B
'?V7$1 @.02713 .10153 @.1469A.417B
'4?1 @.34639 .23745 @1.45A.14B
'8:A(81 .1537 .1634 1.1339A.260B
'44,37C1 @.4062 .663 @.46931A.640B
'D$C1 .1037 .264 .36214A.71B
'44,E7:1 @1.1104 .95325 @1.164A.247B
'<S(A:1 @.914 1.3211 @.74795A.456B
ec/1-@1. @.72254 .26119 @2.7663A.007B
ec/2-@1. @.72 .12631 @5.7704A.000B
ec/3-@1. .51094 .20221 2.526A.013B
23454 1.4664 .72659 2.012A.046B
SANC(,7N @.096329 .02153 @3.4216A.001B
N898:A .065596 .02079 2.3361A.022B
373;1 @.01905 .071905 @.27544A.74B
375;4 .079570 .066454 1.1974A.234B
34;3;4 @.0005 .0413 @1.6637A.099B
36;1 @.25105 .079053 @3.175A.002B
35;3;4 @.11274 .053415 @2.1106A.037B
36;4 @.14311 .069713 @2.052A.043B
396;2 .00164 .064692 .021A.977B
39;3 @.009363 .065534 @.14323A.6B
301;4 @.10419 .06674 @1.5609A.122B
3<S(A: 1.41 1.2576 1.4695A.145B
*******************************************************************************
ec/1 = 1.00*4? @.92006*8:A(8 @1.5269*44,E7: @2.227*<S(A: F .030225*(ren'G
ec/2 = 1.00*?V7$ @1.1230*4? F .62310*44,37C F .36033*D$C @.01229*(ren'G
ec/3 = 1.00*44,37C @.1564*8:A(8 F @2.2953*44,E7:
*******************************************************************************
:@SHuare' .50157 :@Iar@SHuare' .3339
S.8. "% :e&ressi"n .0623 E@stat. E- 236 97. 4.2440A.000B
Cean "% 3e>en'ent Varia1le .011433 S.3. "% 3e>en'ent Varia1le .00024
:esi'ual Su/ "% SHuares .3302 8Huati"n $"&@li=eli)""' 176.5135
A=ai=e ,n%". Criteri"n 152.5135 Sc)*arJ Ia0esian Criteri"n 11.9640
39@statistic 2.003 S0ste/ $"&@li=eli)""' 2009.1
*******************************************************************************
N"tes# ()e null )0>"t)eses "% serial c"rrelati"n A>=0.697B6 n"n@n"r/alit0 "% err"rs
A>=0.02B6 /is@s>eci%icati"n A>=0.09B an' )eter"sce'asticit0 A>=0.03B *ere reKecte'.
.,
1+.4 &erchandise exports usin) annual data' 1*+-2++1
Table +/: Test statistics for cointegrating ran&, merchandise exports using annual
data, +63- to -..+
Maximal eigenvalue test
*******************************************************************************
Null Alternative Statistic 95% Critical Value 90% Critical Value
r = 0 r = 1 4.2629 42.9500 40.2100
r<= 1 r = 2 37.2032 36.000 34.1000
r<= 2 r = 3 26.999 30.7100 2.2700
r<= 3 r = 4 24.052 24.5900 22.1500
r<= 4 r = 5 13.3424 1.0600 15.900
r<= 5 r = 6 1.4904 11.4700 9.5300
*******************************************************************************
Trace test
*******************************************************************************
Null Alternative Statistic 95% Critical Value 90% Critical Value
r = 0 r!= 1 17.3740 109.5700 104.4000
r<= 1 r!= 2 103.1111 1.4500 76.9500
r<= 2 r>= 3 6%.9079 %8.6300 %4.8400
r<= 3 r!= 4 3.910 3.9300 35.00
r<= 4 r!= 5 14.32 23.3200 20.7500
r<= 5 r = 6 1.4904 11.4700 9.5300
*******************************************************************************
N"te# $ist "% ei&envalues in 'escen'in& "r'er are#
.1460 .5242 .41713 .3227 .23421 .029369 0.00
Table +1: E)5 of export supply for merchandise goods, annual data
EM %"r varia1le !"#$ esti/ate' 10 7$S 1ase' "n c"inte&ratin& VA:-2.
*******************************************************************************
3e>en'ent varia1le is '?V7$
50 "1servati"ns use' %"r esti/ati"n %r"/ 1952 t" 2001
*******************************************************************************
:e&ress"r C"e%%icient Stan'ar' 8rr"r (@:ati"A4r"1B
,nterce>t @2.7454 1.9477 @1.4096A.167B
'?V7$1 .15429 .1714 .976A.375B
'4?DV1 @.1737 .29220 @.61044A.545B
'4C37C1 @.069254 .409 @.16937A.66B
'234SA1 .2223 .5357 1.5344A.133B
'8:A(81 @.26962 .27790 @.97022A.33B
'$44,E7:1 @.1247 .59070 @1.3754A.177B
'<S(A:601 @.26271 .955 @.29533A.769B
ec/1-@1. @.4373 .327 @1.3341A.190B
ec/2-@1. @.3473 .19925 @1.7435A.090B
ec/3-@1. @.64439 .54220 @1.15A.242B
SANC(,7N @.024665 .041364 @.5962A.555B
N898:A .05170 .039255 1.3172A.196B
*******************************************************************************
ec/1 = 1.0000*4?DV F @.0973*8:A(8 @1.9319*$44,E7: F .6144*<S(A:60G
ec/2 = 1.0000*?V7$ @1.0541*4?DV F .43*4C37C @1.226*234SA
ec/3 = 1.0000*234SA @ .2622*?V7$ F .1974*4C37C @.9721*<S(A:60
*******************************************************************************
:@SHuare' .277 :@Iar@SHuare' .056910
S.8. "% :e&ressi"n .061539 E@stat. E- 126 37. 1.2464A.290B
Cean "% 3e>en'ent Varia1le .054444 S.3. "% 3e>en'ent Varia1le .063369
:esi'ual Su/ "% SHuares .14012 8Huati"n $"&@li=eli)""' 75.946
A=ai=e ,n%". Criteri"n 62.946 Sc)*arJ Ia0esian Criteri"n 50.5564
39@statistic 1.7642 S0ste/ $"&@li=eli)""' 721.6322
*******************************************************************************
N"tes# ()e null )0>"t)eses "% serial c"rrelati"n A>=0.032B *as n"t reKecte'. ()e null "%
n"n@n"r/alit0 "% err"rs A>=0.12B6 /is@s>eci%icati"n A>=0.412B an' )eter"sce'asticit0
A>=0.446B *ere reKecte'.
.)
1+. &anufacturin) exports usin) "uarterly data' 1*/$"1 0 2+++"4
Table +3: Test statistics for cointegrating ran&, manufacturing exports using uarterly
data, +687+ to -...1
Maximal eigenvalue test
*******************************************************************************
Null Alternative Statistic 95% Critical Value 90% Critical Value
r = 0 r = 1 63.3534 45.6300 42.7000
r<= 1 r = 2 49.0961 39.300 36.400
r<= 2 r = 3 31.2042 33.6400 31.0200
r<= 3 r = 4 29.1198 27.4200 24.9900
r<= 4 r = 5 14.9094 21.1200 19.0200
r<= 5 r = 6 .1219 14.00 12.900
*******************************************************************************
Trace test
*******************************************************************************
Null Alternative Statistic 95% Critical Value 90% Critical Value
r = 0 r!= 1 196.1900 124.6200 119.600
r<= 1 r!= 2 132.366 95.700 91.4000
r<= 2 r!= 3 3.7405 70.4900 66.2300
r<= 3 r>= 4 %2.%363 48.8800 4%.7000
r<= 4 r!= 5 23.4166 31.5400 2.700
r<= 5 r!= 6 .5072 17.600 15.7500
*******************************************************************************
N"tes# $ist "% varia1les inclu'e' in t)e c"inte&ratin& vect"r#
?C(,46 4?C(,4S6 8:A(86 44,37C6 44,E7:6 D$C6 <S(A:6 234546 SANC(,7N6 N898:A6 34;3;46
35;3;46 36;16 36;46 396;26 39;3 an' centre' seas"nal 'u//ies.
$ist "% ei&envalues in 'escen'in& "r'er#
.46929 .3796 .2605 .25263 .1351 .0700 .003454
Table +7: E)5 of export supply for manufacturing goods, uarterly data
8CC %"r varia1le ?C(,4 esti/ate' 10 7$S 1ase' "n c"inte&ratin& VA:-1.
*******************************************************************************
100 "1servati"ns use' %"r esti/ati"n %r"/ 1976;1 t" 2000;4
*******************************************************************************
:e&ress"r C"e%%icient Stan'ar' 8rr"r (@:ati"A4r"1B
,nterce>t @.6620 2.3321 @3.7142A.000B
ec/1-@1. @.70355 .2242 @3.001A.003B
ec/2-@1. @.44670 .096626 @4.6230A.000B
ec/3-@1. .69475 .25926 2.679A.009B
ec/4-@1. 1.6992 .5776 2.909A.005B
23454 1.2659 .64937 1.9494A.055B
SANC(,7N @.021257 .030073 @.7064A.42B
N898:A .0236 .042957 1.923A.057B
34;3;4 @.013273 .06291 @.21105A.33B
36;1 @.16719 .09460 @1.691A.093B
35;3;4 @.0314 .06937 @.56304A.575B
36;4 @.021960 .06707 @.25327A.01B
396;2 @.005762 .04604 @.069455A.945B
39;3 .041726 .02321 .5067A.614B
SC1 @.065763 .02312 @2.36A.006B
SC2 .02193 .024263 .90420A.369B
SC3 @.005423 .022914 @.25497A.799B
3D$C @.4346 .37605 @2.2429A.02B
*******************************************************************************
ec/1 = 1.0000*4?C(,4S @1.0000*8:A(8 @1.273*44,E7: F 1.252*<S(A:G
ec/2 = 1.0000*?C(,4 @1.1249*4?C(,4S F 1.1249*44,37CG
ec/3 = 1.0000*8:A(8 @1.9227*44,37C F 3.7020*44,E7: F 2.74*<S(A:G
ec/4 = 1.0000*44,37C @.65607*8:A(8 F @1.917*44,E7: @.1673*D$C
*******************************************************************************
:@SHuare' .43594 :@Iar@SHuare' .31900
S.8. "% :e&ressi"n .07999 E@stat. E- 176 2. 3.7279A.000B
Cean "% 3e>en'ent Varia1le .01660 S.3. "% 3e>en'ent Varia1le .095730
:esi'ual Su/ "% SHuares .51175 8Huati"n $"&@li=eli)""' 121.607
A=ai=e ,n%". Criteri"n 103.607 Sc)*arJ Ia0esian Criteri"n 0.4142
39@statistic 2.205 S0ste/ $"&@li=eli)""' 1775.1
*******************************************************************************
()e null )0>"t)eses "% serial c"rrelati"n A>=0.0B6 n"n@n"r/alit0 "% err"rs A>=0.74B6 /is@
s>eci%icati"n A>=0.516B an' )eter"sce'asticit0 A>=0.997B *ere reKecte'.
.1
1+.$ &erchandise imports usin) "uarterly data and import unit values' 1*/211 to
2++114
Table +8: Test statistics for cointegrating ran&, merchandise import demand using
import unit values and uarterly data
Maximal eigenvalue test
*******************************************************************************
Null Alternative Statistic 95% Critical Value 90% Critical Value
r = 0 r = 1 %6.1903 33.6400 31.0200
r<= 1 r = 2 24.4327 27.4200 24.9900
r<= 2 r = 3 19.070 21.1200 19.0200
r<= 3 r = 4 5.3142 14.00 12.900
r<= 4 r = 5 2.0655 .0700 6.5000
*******************************************************************************
Trace test
*******************************************************************************
Null Alternative Statistic 95% Critical Value 90% Critical Value
r = 0 r!= 1 107.0734 70.4900 66.2300
r<= 1 r!= 2 50.32 4.00 45.7000
r<= 2 r!= 3 26.4505 31.5400 2.700
r<= 3 r!= 4 7.3797 17.600 15.7500
r<= 4 r = 5 2.0655 .0700 6.5000
*******************************************************************************
N"te# $ist "% ei&envalues in 'escen'in& "r'er#
.37390 .1422 .14694 .043319 .017065
Table +:: E)5 of import demand for merchandise goods using import unit values,
uarterly data
EM %"r varia1le M"#$ esti/ate' 10 7$S 1ase' "n c"inte&ratin& VA:-4.
*******************************************************************************
3e>en'ent varia1le is 'CV7$
120 "1servati"ns use' %"r esti/ati"n %r"/ 1972;1 t" 2001;4
*******************************************************************************
:e&ress"r C"e%%icient Stan'ar' 8rr"r (@:ati"A4r"1B
,nterce>t @1.3470 .1931 @6.7927A.000B
'CV7$1 @.15231 .06636 @1.750A.02B
'238CL(41 1.9213 .56629 3.3927A.001B
'(A:,EE,NC1 .09629 .042992 2.04A.040B
'44,37C1 @.51604 .61032 @.4553A.400B
'4,C4DV1 .61092 .17374 3.5163A.001B
'CV7$2 @.27320 .0472 @3.2244A.002B
'238CL(42 2.0066 .57630 3.419A.001B
'(A:,EE,NC2 .042052 .042674 .9542A.327B
'44,37C2 .69067 .61250 1.1276A.262B
'4,C4DV2 .19654 .17027 1.1543A.251B
'CV7$3 @.031936 .079636 @.40103A.69B
'238CL(43 .5427 .59034 1.4471A.151B
'(A:,EE,NC3 .12295 .041443 2.9667A.004B
'44,37C3 .36360 .5930 .61233A.542B
'4,C4DV3 .60665 .1600 3.7727A.000B
ec/1-@1. @.4064 .059677 @6.174A.000B
SANC(,7N @.00590 .015620 @.54999A.54B
N898:A .012042 .013913 .655A.39B
3(A:,NC @.043436 .040627 @1.0691A.2B
3238CL(4 2.0153 .5414 3.721A.000B
34,C4DV @.74172 .13520 @5.461A.000B
344,37C .9743 .62730 1.4306A.156B
*******************************************************************************
ec/1 = 1.0000*CV7$ @1.9165*238CL(4 F .2322*(A:,EE,NC @1.5949*44,37C
F 1.5949*4,C4DV
*******************************************************************************
:@SHuare' .6035 :@Iar@SHuare' .6076
S.8. "% :e&ressi"n .0462 E@stat. E- 226 97. 9.346A.000B
Cean "% 3e>en'ent Varia1le .0050325 S.3. "% 3e>en'ent Varia1le .077655
:esi'ual Su/ "% SHuares .2293 8Huati"n $"&@li=eli)""' 205.3201
A=ai=e ,n%". Criteri"n 12.3201 Sc)*arJ Ia0esian Criteri"n 150.2640
39@statistic 1.9104 S0ste/ $"&@li=eli)""' 205.3201
*******************************************************************************
()e null )0>"t)eses "% serial c"rrelati"n A>=0.274B6 "% n"n@n"r/alit0 "% err"rs A>=0.25B6
/is@s>eci%icati"n A>=0.445B an' )eter"sce'asticit0 A>=0.099B *ere reKecte'.
.6
1+./ &erchandise imports usin) "uarterly data and import producer price indices'
1*/211 to 2++114
Table +6: Test statistics for cointegrating ran&, merchandise import demand using
import producer price indices and uarterly data
Maximal eigenvalue test
*******************************************************************************
Null Alternative Statistic 95% Critical Value 90% Critical Value
r = 0 r = 1 39.7665 33.6400 31.0200
r<= 1 r = 2 27.360 27.4200 24.9900
r<= 2 r = 3 20.3554 21.1200 19.0200
r<= 3 r = 4 7.2374 14.00 12.900
r<= 4 r = 5 3.229 .0700 6.5000
*******************************************************************************
Trace test
*******************************************************************************
Null Alternative Statistic 95% Critical Value 90% Critical Value
r = 0 r!= 1 9.4251 70.4900 66.2300
r<= 1 r!= 2 5.656 4.00 45.7000
r<= 2 r!= 3 30.226 31.5400 2.700
r<= 3 r!= 4 10.4672 17.600 15.7500
r<= 4 r = 5 3.229 .0700 6.5000
*******************************************************************************
N"te# $ist "% ei&envalues in 'escen'in& "r'er# .22076 .207036 .156026 .055296 .026556
Table -.: E)5 of import demand for merchandise goods using import producer price
indices, uarterly data
8CC %"r varia1le CV7$ esti/ate' 10 7$S 1ase' "n c"inte&ratin& VA:-4.
*******************************************************************************
120 "1servati"ns use' %"r esti/ati"n %r"/ 1972;1 t" 2001;4
*******************************************************************************
:e&ress"r C"e%%icient Stan'ar' 8rr"r (@:ati"A4r"1B
,nterce>t @.77449 .14990 @5.1666A.000B
'CV7$1 @.33191 .094115 @3.5267A.001B
'238CL(41 2.5697 .67627 3.7999A.000B
'(A:,EE,NC1 .0076437 .049104 .15566A.77B
'44,37C1 @.031493 .7650 @.040042A.96B
'4,C44,(1 .4244 .34961 1.2255A.223B
'CV7$2 @.26995 .09699 @2.730A.006B
'238CL(42 2.361 .69607 3.420A.001B
'(A:,EE,NC2 @.02214 .049014 @.57562A.566B
'44,37C2 .61196 .703 .7373A.435B
'4,C44,(2 .35610 .32364 1.1003A.274B
'CV7$3 @.19010 .07206 @2.1799A.032B
'238CL(43 1.5457 .7000 2.132A.031B
'(A:,EE,NC3 .059909 .05007 1.1963A.234B
'44,37C3 1.2095 .75757 1.5966A.114B
'4,C44,(3 .26453 .34436 .761A.444B
ec/1-@1. @.3740 .074211 @5.0990A.000B
SANC(,7N .01291 .01763 .7323A.466B
N898:A @.0029594 .017147 @.17259A.63B
3(A:,NC @.0063219 .0490 @.1279A.9B
3238CL(4 1.370 .66023 2.723A.006B
34,C44, @.93521 .32365 @2.96A.005B
344,37C .7749 .0395 1.0915A.27B
*******************************************************************************
ec/1 = 1.0000*CV7$ @1.3922*238CL(4 @2.4301*44,37C F 2.4301*4,C44,(
*******************************************************************************
:@SHuare' .51665 :@Iar@SHuare' .40702
S.8. "% :e&ressi"n .05979 E@stat. E- 226 97. 4.712A.000B
Cean "% 3e>en'ent Varia1le .0050325 S.3. "% 3e>en'ent Varia1le .077655
:esi'ual Su/ "% SHuares .3465 8Huati"n $"&@li=eli)""' 10.503
A=ai=e ,n%". Criteri"n 157.503 Sc)*arJ Ia0esian Criteri"n 125.4522
39@statistic 1.9193 S0ste/ $"&@li=eli)""' 10.503
*******************************************************************************
N"te# ()e null )0>"t)eses "% serial c"rrelati"n A>=0.316B6 "% n"n@n"r/alit0 "% err"rs
A>=0.711B6 /is@s>eci%icati"n A>=0.07B *ere reKecte'. 4r"1le/s "% )eter"sce'asticit0
A>=0.007B >ersiste'.
./
1+.( &erchandise and manufacturin) imports usin) annual data' 1*/+ to 2++1
Table -+: Test statistics for cointegrating ran&, merchandise import demand using
annual data
Maximal eigenvalue test
*******************************************************************************
Null Alternative Statistic 95% Critical Value 90% Critical Value
r = 0 r = 1 3%.7862 27.4200 24.9900
r<= 1 r = 2 17.507 21.1200 19.0200
r<= 2 r = 3 11.5334 14.00 12.900
r<= 3 r = 4 3.0347 .0700 6.5000
*******************************************************************************
Trace test
*******************************************************************************
Null Alternative Statistic 95% Critical Value 90% Critical Value
r = 0 r!= 1 6.2049 4.00 45.7000
r<= 1 r!= 2 32.417 31.5400 2.700
r<= 2 r!= 3 14.560 17.600 15.7500
r<= 3 r = 4 3.0347 .0700 6.5000
*******************************************************************************
N"tes# 32 "1servati"ns %r"/ 1970 t" 2001. 7r'er "% VA: = 1.
$ist "% varia1les inclu'e' in t)e c"inte&ratin& vect"r#
CV7$6 4CDV6 4C37C. 234SA
$ist "% ,-0. varia1les inclu'e' in t)e VA:#
SANC(,7N6 N898:A6 345
$ist "% ei&envalues in 'escen'in& "r'er#
.67317 .42755 .30261 .090475
Table --: Test statistics for cointegrating ran&, manufacturing import demand using
annual data
Maximal eigenvalue test
*******************************************************************************
Null Alternative Statistic 95% Critical Value 90% Critical Value
r = 0 r = 1 29.92%0 27.4200 24.9900
r<= 1 r = 2 17.767 21.1200 19.0200
r<= 2 r = 3 1.1545 14.00 12.900
r<= 3 r = 4 .11549 .0700 6.5000
*******************************************************************************
Trace test
*******************************************************************************
30 "1servati"ns %r"/ 1972 t" 2001. 7r'er "% VA: = 2.
$ist "% varia1les inclu'e' in t)e c"inte&ratin& vect"r#
CCAN 4C37C 4CCAN 234SA
$ist "% ,-0. varia1les inclu'e' in t)e VA:#
SANC(,7N6 N898:A6 345
$ist "% ei&envalues in 'escen'in& "r'er#
.63120 .44692 .037753 .003422
*******************************************************************************
Null Alternative Statistic 95% Critical Value 90% Critical Value
r = 0 r>= 1 48.9627 48.8800 4%.7000
r<= 1 r!= 2 19.037 31.5400 2.700
r<= 2 r!= 3 1.2700 17.600 15.7500
r<= 3 r = 4 .11549 .0700 6.5000
*******************************************************************************
N"tes# 30 "1servati"ns %r"/ 1972 t" 2001. 7r'er "% VA: = 2.
$ist "% varia1les inclu'e' in t)e c"inte&ratin& vect"r#
CCAN6 4C37C6 4CCAN6 234SA
$ist "% ,-0. varia1les inclu'e' in t)e VA:#
SANC(,7N N898:A 345
$ist "% ei&envalues in 'escen'in& "r'er#
.63120 .44692 .037753 .003422
.5
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