trade liberalization and the performance of the tobacco...

Journal of Emerging Issues in Economics, Finance and Banking (JEIEFB) An Online International Monthly Journal (ISSN: 2306-367X)

2014 Vol: 3 Issue 1

962

www.globalbizresearch.com

Trade liberalization and the performance of

the tobacco sector in Malawi

Mwiza Orton Thindwa,

Economist,

Ministry of Industry and Trade,

Government of Malawi.

Email: [email protected]

Venkatesh Seshamani,

Professor of Economics,

University of Zambia,

Zambia.

Email: [email protected]

___________________________________________________________________________

Abstract

This study seeks to establish the impact of trade liberalization in Malawi. Specifically, it aims

to establish the relationship between trade liberalization and the growth of tobacco exports

during the period 1970 to 2009. The paper considered the nominal exchange rate, availability

of arable land, access and use of IMF aid and regional integration as primary factors with the

potential to affect export earnings of tobacco. Inflation rate and FDI also were considered as

secondary variables. The paper reviews similar studies that have been carried out on this theme

which reveal dissimilar results. It also reviews various theories. Some of them support the

hypothesis that international trade produces both static and dynamic gains for the trading

countries; while some other theories argue that these gains are not always realized in practice.

We have used the Ordinary Least Squares technique to estimate a linear relationship between

tobacco exports and all the independent variables mentioned above. The econometric results

show that the only factors that are significantly related to the growth of tobacco export earnings

in Malawi are FDI inflows and availability of arable land for tobacco farming. Trade

liberalization has had no notable impact on the tobacco sector.

___________________________________________________________________________

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mailto:[email protected]


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1. Introduction

Malawi is one of the major producers of tobacco in the world. Tobacco is an important

factor for Malawi’s development for a variety of reasons. It is the country’s main export crop,

accounting for nearly 55% of the country’s export. It contributes to 13% of the national GDP

and on average 8% of the annual budgeted revenue. It is also a major generator of employment.

According to estimates, the tobacco sector hires 650,000 to 2 million permanent and seasonal

people every year. This constitutes about 20% of the total labor force. And it also contributes

significantly to rural incomes since most of the growers and employees in the sector are from

rural areas. According to the Integrated Survey of 2004 – 05, tobacco sales contributed more

than 60% of the rural incomes. The importance of the tobacco sector to poverty reduction also

stems from the fact that there are more than 20,000 smallholder farmers who are engaged in

tobacco farming today.

The growth rate of tobacco exports has displayed notable volatility during the period 1970

to 2009, the period covered in this paper. Like the economies of most developing countries

especially in sub-Saharan Africa, the Malawian economy too reeled under the impact of the oil

shock in 1979. The country soon had little option but to agree to the Structural Adjustment

Program (SAP) prescribed by the International Monetary Fund (IMF) and the World Bank.

Under the reforms umbrella of SAP, trade liberalization was implemented in 1988. As part of

trade liberalization, the exchange rate was freed from control, leading to a series of

devaluations; all non-tariff barriers were removed; average tariffs were reduced to below 16%;

and most licensing requirements on imports and exports were eliminated.

Specifically with respect to tobacco, the Act restricting small farmers from growing tobacco

was abolished in 1993; tariffs on imports of tobacco for uses other than cigarette production

were brought down; and the export levy on tobacco was reduced to 4% and then eliminated

altogether in 1998. Currently, the only requirements that remain in the tobacco sector are two-

fold: 40% of the export proceeds have to be surrendered to the Reserve Bank of Malawi; and

export licenses are needed for the export of raw tobacco.

2. Objectives and Hypotheses

The objective of this paper is to see if the package of trade liberalization measures has

benefitted the tobacco sector in Malawi. Has it been providing improved access for Malawian

tobacco to international markets and thereby raising exports? Our main hypothesis in this regard

is that this has not happened and that whatever benefits the tobacco sector have been mainly

due to factors other than trade liberalization.



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It may be noted here that although there have been several studies of the impact of trade

liberalization on the Malawian economy; this is the first paper that analyzes the impact

specifically on the tobacco sector.

Stemming from the above principal objective and hypothesis, the specific null hypotheses

that are tested in this paper are the following:

Trade openness has not significantly contributed to the growth of the tobacco sector in

Malawi;

Post-trade liberalization tobacco export earnings have not significantly increased;

Exchange rate liberalization has not had any significant impact on tobacco exports;

Tobacco exports have not been affected by pre- and post-trade liberalization inflation

rates.

3. Literature Review

3.1 Theories

There are three major theories that explain why any country can benefit by trading in a

liberalized environment. All these theories are a priori applicable to Malawi as well. These three

theories are:

Ricardo’s theory of comparative advantage: The theory postulates that if each nation

specializes in production of the commodity in which it has a comparative advantage, gains from

trade would be realized (Salvatore, D., 2007). The gains from trade are both static and dynamic

gains. Static gains from trade stem from the fact that countries have different factor endowments

and therefore, the opportunity cost of production varies between countries. The gains are

measured by the resource gains that could be obtained by exporting to get imports more

cheaply; in terms of resources given up in comparison with producing the good oneself

(Thirlwall, A. P., 2000). Dynamic gains from trade on the other hand result from increased

productivity of resources. International trade improves the access to export markets, and if

increasing returns are assumed to hold, countries stand to gain.

Malawi could enjoy these gains from trade as a result of trade liberalization through

improved access to international markets. The foreign exchange realized from the sale of

tobacco could boost the country’s foreign reserves and thereby its import cover. Dynamic gains

could manifest through increased productivity of labor, acquisition of new knowledge and

technology.

Heckscher-Olin (H-O) theory: The H-O theory builds from Ricardo’s theory of comparative

advantage. It also advocates that countries can carry out international trade by exporting

commodities of their comparative advantage. It goes further to define comparative advantage

in terms of factor abundance and intensity in a given nation. Thus a country has comparative



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advantage if it has a particular resource in abundance and if the ratio of that resource in relation

to others is high in production (factor intensity). Thus, the nation has comparative advantage in

producing a commodity which uses the resource that depicts these characteristics (Salvatore,

2007). Specialization in production and trade between countries generates a high standard of

living for the countries involved.

Malawi, like most developing nations is a labor-abundant nation with a lot of natural

resources such as land and water. Therefore, capitalizing on these resources, the tobacco sector

has employed both formal and informal workers to work on these resources in growing the

tobacco.

Endogenous growth theory: The theory suggests that economic growth is as a result of internal

factors such as investment in human capital, knowledge as well as innovation. Countries stand

to gain from investment in research and development as well as developing its human capital.

In doing so, economies of scale in production can be cultivated. Furthermore, efficient

channeling of domestic resources across sectors can be realized by reducing price distortions.

Economic development stems from externalities coming from a country employing advanced

technology in production (Howitt, 1998).

The tobacco sector in Malawi mainly utilizes resources internal to the country in promoting

the sector. Some farmers belonging to clubs have undergone capacity building initiatives in

order to improve their knowledge base. The nation has also engaged in modern farming

methods and marketing the tobacco leaf. In addition, the country has employed policy measures

in favor of tobacco farming as well as export promotion as has already been alluded to earlier.

Thus, on the basis of theoretical rationality, one should expect a country like Malawi to

achieve improvements in export growth, economic growth and human welfare through trade

liberalization and openness. The situation on the ground, however, may not always be in sync

with the expectations stemming from theory. This is because growth and welfare may be

determined by several factors besides trade liberalization which, from a more macro

perspective, may not turn out to be a significant factor impacting on growth and welfare.

3.2 Empirical studies

Indeed, several empirical studies demonstrate that the impact of trade liberalization may

vary across spatial-temporal regions that do not permit uniform and categorical conclusions.

Table 1 below provides a fairly extensive sample of studies in this regard.



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Table 1: Selected studies on the impact of trade liberalization

Author(s) and Date of

Publication

Countries Covered in the

Study

Impact of Trade

Liberalization

S. Pohit, 2013 India and Pakistan Increased gains from trade

A. Elshennawy, 2012 Egypt Increase in market size and

exports; but slowing of

economic growth and

increase in unemployment

R. Hasan et al., 2012 Egypt Overall reduced

unemployment

A. Hasan, 2010 Pakistan Low trade benefits

E. N. Kumwenda, 2010 Malawi Decline in the growth of the

manufacturing sector

Y. H. D. Liu et al., 2008 China Growth in exports,

employment and technology

G. Sharma, 2008 Nepal Growth in tea exports and

tea industry; smallholders

benefited

G. Otieno, 2008 Kenya Closure of small textile

business, increase in

unemployment, but

improved welfare of

consumers through cheaper

imports.

B. F. Aka, 2006 Cote D’Ivoire Short-term reductions in

revenue, long-term benefits

of growth

N. Annabi et al., 2005 Senegal Small increases in poverty

and inequality in the short

run but improvements in

capital accumulation and

poverty reduction in the long

term



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O. Njikam, 2003 Cameroon Growth of the electrical

industry and increase in

employment

P. Wobst, 2002 Malawi, Mozambique,

Tanzania, Zambia and

Zimbabwe

Different results in different

countries depending on their

economic and geographical

structures

D. Tussie and C. Aggio,

2003

Zambia Only minor positive impact

on copper industry

Source: Authors’ compilation from the literature

It is clear from the above table that the impact of trade liberalization has not been uniform

across space and time. In sum, the overall impact of trade liberalization emerging from the

selected sample of studies is not definitive but rather inconclusive.

4. Methodology

4.1 Data and data sources

The study uses time series data for the period 1970 to 2009. Secondary data have been

collected from the Tobacco Control Commission (TCC), Tobacco Association of Malawi

(TAMA), Ministry of Finance, the National Statistical Office, the Reserve Bank of Malawi, and

the Food and Agriculture Organization (FAO) website. These institutions acquire the data

mainly through surveys and studies.

4.2 Model specification

A multiple regression model has been formulated with tobacco export earnings as the

dependent variable. The explanatory variables selected are:

- Nominal exchange rate and regional integration;

- Pre- and post-liberalization inflation rates;

- Amount of arable land available for tobacco farming since tobacco is largely grown by

smallholder farmers;

- Use of IMF credit since SAPs were a prerequisite for obtaining aid from IMF and

World Bank;

- FDI net inflows since many investors have brought funds to support the tobacco sector,

especially in the area of contract farming;

- A structural break parameter since 1988 is the break date when Malawi adopted

liberalization.

Based on this, tobacco exports = f (exchange rate, inflation, regional integration, arable

land, IMF credit, and FDI net inflows).



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For proper analysis of the regression results, the model for this study is in log form as

follows:

𝐿𝑇𝑜𝑏𝑒𝑥𝑝 = 𝛽0 + 𝛽1𝐿𝑒𝑟 − 𝛽2 𝐿𝑖𝑟 + 𝛽3 𝐿𝑎𝑟𝑎𝑏𝑙𝑒 + 𝛽4𝐿𝑖𝑚𝑓 + 𝛽5 𝐿𝑓𝑑𝑖 + 𝛽6 𝑆𝐵 +

𝛽7 𝑟𝑒𝑔𝑖𝑛𝑡 + 𝑈𝑡 ………………………………………………………………………….. (1)

A similar model with the inclusion of an interaction of the break year (SB) with the

exchange rate has also been run in order to analyze the impact of liberalization together with

regional integration on tobacco export earnings. The model is presented below:

𝐿𝑇𝑜𝑏𝑒𝑥𝑝 = 𝛽0 + 𝛽1 𝐿𝑒𝑟 − 𝛽2𝐿𝑖𝑟 + 𝛽3𝐿𝑎𝑟𝑎𝑏𝑙𝑒 + 𝛽4𝐿𝑖𝑚𝑓 + 𝛽5𝐿𝑓𝑑𝑖 + 𝛽6 𝑟𝑒𝑔𝑖𝑛𝑡 +

𝛽7𝑆𝐵 + 𝐵8𝑆𝐵𝐿𝑒𝑟 + 𝑈𝑡 …………………………………………………………………. (2)

The variables specified in the two models above are as follows:

L1Tobexp: This variable defines the level of tobacco exports earnings.

Ler: The exchange rate of the Malawi Kwacha that prevailed before and after trade

liberalization.

Lir: It depicts pre- and post-liberalization inflation rates.

Larable: It shows the amount of land in hectares available for tobacco farming.

Limf: This is the amount of aid available as a result of adoption of SAPs

Lfdi: Inflows from investors in the tobacco sector.

Regint: Represents the dummy variable for regional integration, equal to 1 for the presence of

regional integration and zero otherwise. The year 1982 has been chosen as the year for regional

integration. This is because this was the year Malawi joined a regional grouping (COMESA)

in order to further economic and political development.

SB: Represents the structural break year of 1988, since this is the year when the country

implemented trade liberalization.

SBLer: This is the interaction variable for regional integration and the exchange rate.

Ut: This is the error term.

4.3 Estimation and diagnostics

The following time series econometric tests have been carried out:

- The Dickey-Fuller test to check for the presence of unit roots and non-stationarity;

- Breuch-Pagan-Godfrey, Durbin-Watson and Variance Inflation factor (VIF) tests to

test for heteroskedasticity, autocorrelation and multicollinearity whose presence will violate the

assumptions of Ordinary Least Squares and thereby render the regression results invalid.

1 The L stands for natural logarithm.



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5. Presentation and Interpretation of Results

5.1 Results

Details of all the test results are provided in the Appendix. Here we summarize the results.

- To test for the presence of unit roots, the Dickey Fuller test was carried out on all but

dummy variables. The null hypothesis of stationarity was significant at 5% after differencing

once for tobacco export earnings (ltobexp), exchange rate (ler), and arable land (larable). In

contrast, the Dickey Fuller results for the inflation rate (lir), IMF credit (limf), and FDI (lfdi)

did not depict any sign of unit roots, when the test was first run on them.

- The Breusch-Pagan-Godfrey test showed constant variance (homoskedasticity);

- The VIF test shows the absence of multicollinearity, since the individual values of the

VIF are below five. Any value above five implies the presence of multicollinearity.

- The Durbin-Watson test did not clearly depict the presence or absence of

autocorrelation. This is because the computed test statistic lies in the area of indecision; that is

𝑑𝐿 ≤ 𝑑 ≤ 𝑑𝑢, where d is the test statistic and dL and du are the upper and lower bounds of the

Durbin-Watson table.

The two tables below show the regression results of the models (1) and (2) presented in the

section on model specification.

Table 2

VARIABLES D.ltobexp

D.ler 0.0393

(0.145)

Lir -0.0183

(0.0639)

D.larable 2.265**

(0.960)

Limf 0.00444

(0.0569)

Lfdi 0.0940**

(0.0364)

SB -0.157

(0.117)

Regent -0.0221

(0.146)

Constant -1.444

(1.195)

Observations 29

R-squared 0.350

Standard errors in parentheses

*** p<0.01, ** p<0.05, * p<0.1



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Table 3

(1)

VARIABLES dltobexp

D.larable 2.443**

(1.011)

Limf 0.0207

(0.0590)

Lfdi 0.113**

(0.0409)

Lir -0.0309

(0.0653)

D.ler 0.0614

(0.149)

Regent -0.0281

(0.276)

_ISB_1 -0.00794

(0.272)

Ler -0.00384

(0.358)

_ISBXler_1 -0.0480

(0.357)

Constant -2.004

(1.319)

Observations 29

R-squared 0.404

Standard errors in parentheses

*** p<0.01, ** p<0.05, * p<0.1

5.2 Interpretation of Results

FDI inflows were significant with a positive sign of the coefficient. This implies that

investments made in the tobacco sector, have had an impact on the export levels and

consequently the earnings. This conclusion concurs with studies by Taylor (1998) and

Wacziarg (2001) who established that investment was key to economic growth, thus sound

investment policies would result in improved economic performance.

The availability of arable land was also significant with a positive sign, implying that an

increase in the hectares of land by 1% for instance, results in about 2.3% increase in export

earnings. Land is one of the abundant factors of production resulting in increased tobacco

harvests, and consequently into increased export earnings.

The nominal exchange rate, regional integration, inflation, and the IMF credit use were all

insignificant. The dummy for structural break (SB) was also insignificant, and so was the

interaction of the SB and the exchange rate. All these are variables related to trade liberalization.



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The insignificance of the variable of the exchange rate devaluation on the tobacco export

growth is in concurrence with a study by UNCTAD (1991), where it concluded that there was

no significant relationship between export growth and currency devaluation. The main reason

given is that other independent factors such as terms of trade also play a significant role in

export growth determination.

Regional integration has produced similar results in past studies. For instance, Forouton

(1993) in a study on trade liberalization on Sub-Saharan African countries concluded that there

was no meaningful integration among these countries. This is because of the diverse

characteristics of the economies and a form of trade protection that is still present. Hence, there

has been no significant influence of regional integration on trade.

On the overall, the value of the Coefficient of Determination R2 is not a good sign of the

goodness of fit. One likely reason for the low value is that performance of the agricultural sector

is determined by a number of factors. Therefore, this implies that there are other factors that

influence tobacco exports. However, the focus of this study, trade liberalization, only influences

the exports by 35%. This implies that there must be key determinants of tobacco export earnings

in Malawi, other than trade liberalization. The other likely reason could be unavailability of

data for some important explanatory variables which were thus dropped from the model, such

as, indexes for non-tariff barriers and effective protection.

6. Conclusion

The conclusion, is that trade liberalization has had no effect on the growth of the tobacco

sector. The level of export earnings has not been influenced by trade liberalization. All

independent variables directly relating to trade liberalization have been found to be

insignificant. Therefore, trade liberalization has not contributed to the growth of the tobacco

sector, and its export earnings. Tobacco has always been favored for export, even before trade

liberalization; as such trade liberalization may have had no impact. This study can only attribute

growth of the export sector to FDI inflows and availability of arable farming land. This

deduction is similar to that established by Mbekeani (2007), who found no impact of trade

liberalization on the overall economy of Malawi.

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Appendix

Dickey Fuller Test Results for Stationarity.

1. Tobacco Export Earnings.


http://www.wto.org/


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2. Exchange Rate

3. Arable Land

4. Inflation

5. IMF Credit

6. FDI Inflows

MacKinnon approximate p-value for Z(t) = 0.0000 Z(t) -5.962 -3.662 -2.964 -2.614 Statistic Value Value Value Test 1% Critical 5% Critical 10% Critical Interpolated Dickey-Fuller

Dickey-Fuller test for unit root Number of obs = 38

. dfuller d.ltobexp



. dfuller d.ler



. dfuller d.larable



. dfuller lir



. dfuller limf



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Breusch-Pagan test for heteroskedasticity

Since the p-value is greater than the signficance level of 5%, we fail to reject the null

hypothesis of homoscedasticity.

VIF test for multicollinearity

Results of the VIF test show the absence of multicollinearity, since the individual values of

the VIF are below five. Any value above five implies the presence of multicollinearity.

Durbin-Watson test for autocorrelation

The test results below do not clearly depict the presence or absence of autocorrelation. This

is because the computed test statistic lies in the area of indecision; that is 𝑑𝐿 ≤ 𝑑 ≤ 𝑑𝑢, where

d is the test statistic and dL and du are the upper and lower bounds of the Durbin-Watson table.



. dfuller lfdi

Prob > chi2 = 0.7602 chi2(1) = 0.09

Variables: fitted values of D.ltobexp Ho: Constant varianceBreusch-Pagan / Cook-Weisberg test for heteroskedasticity

Mean VIF 1.98 D.ler 1.22 0.820773 D.larable 1.33 0.753997 lfdi 1.50 0.668641 lir 1.77 0.564568 limf 2.50 0.400045 SB 2.54 0.393618 regint 2.98 0.335498 Variable VIF 1/VIF

Durbin-Watson d-statistic( 8, 29) = 1.482847

Number of gaps in sample: 3

. dwstat

. do "C:\Users\PLANNING\AppData\Local\Temp\STD02000000.tmp"

end of do-file.


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