The Impact of Trade Openness on Economic Growth in Somalia

The potential effect on economic development has been a contentious and important issue in both international trade and economic growth. According to numerous research, economic growth and trade openness are strongly related. Trade openness has many advantages, including the capacity to increase the possibilities of facilitating export and import while creating jobs. it can considerably accelerate economic growth. Therefore, trade openness is a very essential tool for economic growth for both developed and emerging economies [1].

Currently, there is no self-sufficient country in the world which produces all the goods it requires. Therefore, each nation tries to create the goods in which it has a competitive advantage. Part of those items is exchanged for other products produced more effectively by other nations. The basis of international trade has been substantially extended by the relative differences in factor endowments, technology, tastes, etc [2]. The main driver of economic growth, according to neoclassical economists, is trade growth. similarly, they asserted that there is a strong positive relationship between trade and economic growth. Given its importance, both industrialized and emerging nations are more focused on raising their output. For instance, output raises productivity levels and can satisfy the rising demand for products and services as a result of increased trade openness. In given circumstances, emerging market economies would afterwards emerge as the primary global "engine of fresh demand growth and spending power" [3]. Emerging market economies would have the largest economies in the world, possibly surpassing that of the G6 nations—the United States, United Kingdom, France Italy, Japan, and Germany - in 2050 [3].

International trade may increase efficiency, information diffusion, and technological innovation, and what ultimately matters most is inclusive growth and poverty reduction. In Somalia, the economy has always been very open, with imports and exports each contributing significantly to the gross domestic product (GDP) of the nation. Moreover, Somalia should restore its productive sectors, generate income and jobs, and reduce its enormous structural trade deficits, which have averaged over 80% of GDP since 2015, in order to increase export competitiveness [4]. Somalia exports to a relatively small number of markets. In 2018, more than 83per cent of all commodities exported were made up of its top five export goods. These exports, which are dominated by live animals, are mainly unprocessed primary commodities that do not have an impact on other economic sectors and are susceptible to shocks from the environment and other factors [4]. Additionally, Somalia only exports to a select group of nations; in 2018, 82 per cent of its goods were shipped to only five countries, primarily the United Arab Emirates, Oman, and Saudi Arabia. The selling of current exports to new markets and areas with untapped potential might greatly boost Somalia's annual export revenue for goods. Sesame seeds and fish have the greatest potential for export growth. By looking for new markets, there is also some possibility to enhance the export of livestock, although economic analysis indicates that several Gulf markets might already be saturated. Fruit, meat, and gums and resins (frankincense, myrrh) have the potential to see higher sales. East and South Asian nations provide the most potential for development. The national trade plan of Somalia might give priority to certain export potential. Many of Somalia's exporters are constrained by a limited or unstable domestic supply [4].

The findings of the trade openness studies are extensively examined in current literature due to their significance. Trade openness significantly boosts economic growth in regional as well as country specific for example, Trejos and Barboza [5] was done on the relationships between trade openness and economic growth in a panel of 23 Asian economies. The authors made the case that trade openness accelerates economic growth. Generally, their research showed that trade openness had a significant impact on those countries' ability to build their economies. Various trade openness measures are examined, and varied results are found.

First, while simply taking Latin American nations into account, a somewhat favourable association between trade openness and growth is discovered. Second, a negative link between the variables is discovered after eliminating outliers and taking into account all importer countries [6]. Overall, their research showed that trade openness had a significant impact on those countries' ability to build their economies. The researcher included these variables in the study since the authors also suggested that the labor force, technology, and financial development have all significantly contributed to raising the level of economic output across the globe. But according to the literature, none of this research looked at how trade openness affects economic growth in developing market economies. This research encourages us to experimentally examine how trade openness affects economic growth in the top trading economies in the globe.

In the context of Africa, this study has been able to establish the impact of trade openness on economic growth in Nigeria and the idea that commerce with other nations can improve individuals' quality of life, which in turn leads to quicker growth. Trade policy, imports, and exports have all helped the economy grow [7]. A variety of results are obtained from testing different trade openness indicators. First, when only Latin American nations are considered, there is a positive link between trade openness and growth. Second, a negative correlation between the variables was discovered after removing outliers and accounting for all importing nations [6].

The current study concentrated on Somalia, one of the least developed countries of sub-Saharan nations. The Somali people have endured years of devastation from war and crippling poverty. Somali economy is not diversified as its gross domestic product depends on agriculture. Agriculture represents 65% of domestic production [8-10]. According to the 2001 UN Human Development Report, Somalia was rated 161st out of 163 nations, with a 43 per cent poverty rate and a 73 per cent subsistence rate. Only 22% of primary school-age kids attend school and 22% of kids die before they turn five [11]. Therefore, the objective of this study is to ascertain the impact of trade openness with control variables on economic growth.

3.1 Data

Time series data for Somalia from 1985 to 2017 were used in this study. The World Bank and the Statistical, Economic and Social Research and Training Centre for Islamic Countries (SESRIC) provided the information for all variables. Trade openness, labour force, gross fixed capital formation, and economic growth are all factors in the model. Natural logarithms were constructed out of all the variables. Table 1 outlines the data sources and description, while Figure 1 shows the time charts for the indicators examined in the study.

Table 1. Variable description and sources

3.2 Econometric modelling

To accomplish the goal, this study adhered to the specifications of the model of [13, 15, 16, 19] considered not only economic growth but added additional variables to their model specification, like inflation, FDI, financial development which are essential to the model's health and soundness. The model is expressed mathematically as follows:

lnEG_t = β0 + β1lnTO_t + β2lnLF_t + β3GFCF_t + ε_{t    (1)}

lnEG_t is the log of economic growth in year t, lnTO_t is the log of trade openness in year t, lnLF is log of the labour force in year t, lnGFCF is log gross fixed capital formation in year t. Finally, εt describes the error term in time t.

We performed unit root analysis as one of the procedures to verify whether the variables are stationary or not. Prior to doing a cointegration analysis, this is the initial stage in the time series analysis process.

The reason for this is that we were avoiding finding any unreliable findings. Due to this, we utilized the two tests that are often used in time series econometrics. The Augmented Dickey Fuller (ADF) and Philips Perron (PP) tests were used to identifying the order of integration of the variables employed in this investigation. The variables of the attention must be combined at a level I (0) or first difference I (1) in order to proceed with the detection of cointegration in the model. To do this, we used the cointegration approach proposed by Johansen and Juselius in 1990. this cointegration strategy is recommended above other competing cointegration approaches because it identifies the cointegrating vectors in an unconstrained vector autoregressive (VAR) system using the maximum likelihood method.

The rank of the matrix is first determined before we begin estimating the co-integration approach of Johansen and Juselius. Eq. (2) illustrates how this enables us to split the cointegrating rank matrix into the long run and the speed of adjustment.

∏= αβ    (2)

where, vector speed of adjustment is α, and the long-run equilibrium vector is β. The presence of at least one vector in the model can be inferred if the rank of the matrix rises to one. This can be used to demonstrate the co-integration and correlation between the model's variables.

The next step is to determine the elasticity of the long-run coefficient of the variables after estimating the long-run relationship between the variables in our model. to do this, we use the Fully Modified Ordinary Least Squares (FMOLS) approach, one of the many estimating techniques. This estimate approach was chosen because it can address diagnostic issues with serial correlation and endogeneity problems. The ability of FMOLS to offer reliable and effective estimators even for data with a small sample size is another benefit. The FMOLS approach produces outcomes that are completely accurate, efficient, and consistent. The residual's symmetric and one-sided long-run covariance matrices were used as initial estimates by this estimator.

1.png

Figure 1. The trend of data series. Legend: LRGDP, LPG, LFGC, and LTO stand for the natural logarithm of real gross domestic per capita, population growth, gross fixed capital, and trade openness, respectively

The purpose of this research is to ascertain how trade openness affects Somalia's economic growth between 1985 and 2017. The study employed the multivariate cointegration and FMOLS model to assess the long-run association between the variables; CCR method is used for a robustness check. The PP and ADF tests presented that the series are integrated at first difference. The findings of the Johansen cointegration test approve that the presence of the long-run connection among the variables in Somalia. Moreover, the results of the FMOLS model demonstrated that trade openness had a significant, negative long-term effect on Somalia's economic development. Besides gross capital formation and labour force stimulates economic growth in Somalia. However, trade openness and economic growth nexus is an issue that is currently being debated in the literature. In some research, this relationship was found to be positive, whereas in others it was found to be negative or perhaps insignificant. The analytical approach and country-specific features may be held responsible for the inconsistent outcomes.

Based on the empirical findings, the study demonstrates the necessity of implementing policies intended to increase economic activity and investment in crucial industries such as implementing trade reforms that will boost exports and economic growth. In order to further encourage economic growth, create job opportunities, foster innovations, and ensure effective resource allocation, the industrial base must be expanded.

Implementing a policy to turn the unfavourable effect of trade openness on economic growth into a positive and supporting factor will assure favourable trade which supports long-term economic growth. This was carried out as a result of research showing that trade openness hinders economic growth. Additionally, these measures to reduce the trade deficit include making efficient trade and monetary policies, stabilizing inflation, encouraging exports, and increasing the productivity of endowment factors. Therefore, a Somali government must maintain a healthy balance between imports and exports activities because it impacts economic growth in Somalia.

Despite the promising results, this study suffers from some limitations. This study has been conducted using the Fully Modified Least Squares method (FMOLS). Another method like an Autoregressive Distributed Lag (ARDL) analysis of the nexus between trade openness and economic growth in Somalia would be better to use in future research. One of the advantages of the ARDL test is that it estimates the short-term and long-term relationship over FMOLS which states only long-term effects between the variables. Further, alternative measures of openness can also be used in future research.