Import and export demand functions and the Orcutt Hypothesis: evidence from South Africa

The South African economy is subject to balance-of-payments constraints that retard the growth process before it is able to deliver higher per capita incomes to all South Africans. Whilst most studies that have embarked on addressing this phenomenon have used price and income elasticities as primary determinants of foreign trade, the present study uses the Orcutt hypothesis to investigate whether South Africa’s trade flows respond to exchange rate changes faster than they respond to relative price changes. Particularly, we employ the vector error correction (VECM) technique to estimate both the import and export demand functions and generate the generalised impulse response functions based on cointegration and error correction procedures of Johansen and Juselius (1990) to test the Orcutt hypothesis. Our results of the cointegrated models indicate that South Africa’s trade flows are predominantly influenced by income-both domestic and foreign-, relative prices, exchange rates. The results of the generalised impulse response analysis confirm the existence of Orcutt hypothesis in the South African import demand model and reject it in the case of export demand. According to the results, it takes about two quarters for South African imports to adjust to changes in relative prices and one quarter to adjust to changes in the nominal exchange rate. Meanwhile, export demand, on the other hand, takes about two to respond to changes in relative price and four quarters to respond to changes in the exchange rate. Therefore, on the basis of these results, we recommend that in order to reduce balance -of- payment constraints, South Africa should focus more on strengthening domestic industries and expanding the domestic markets. This should be done by paying a close attention to how exchange rate devaluation policies influence demand for foreign produced goods and by applying more intense commercial policy measures on imports, such as imports taxes and quotas as expenditure switching tools to boost domestic exporting industries.

Grantor dc:publisher.institution

University of Zululand

Year dc:date.issued

2018

Author dc:creator

• Myeni, Samkelo K

• exchange rate --Orcutt hypothesis --relative prices --trade flows and VAR-VECM

Licence

• https://devspace.unizulu.ac.za/bitstreams/4142fb7d-b953-4842-8804-3e86e0dc7140/download