The Impact of BRICS alliance on South Africa’s economy - a VECM approach.
Mr Ncube Prince Zwelibanzi
University of Fort Hare,department of Economics
Miss Ncube Free P
University of FortHare,department of economics
Professor Ncwadi R
Nelson Mandela Metropolitan University,department of economics
ABSTRACT
This paper examines first the impact of the BRICS alliance on South Africa’s economy and secondly
the impact that trade openness in the alliance has on South Africa’s economy. The study uses series
data from 1980 to 2012 and employs up to date econometric methodologies- unit root and vector error
correction model estimates to achieve its aims. The empirical result reveals that international trade has
contributed a lot to the high economic growth rates experienced by the BRICS economies during the
recent decades. However, it is also found that international trade is not the only contributing factor.
Human Capital formation, Gross domestic capital formation and real effective exchange rate
appreciation are equally important contributors. Results of the study however reveal that South
Africa’s trade openness in the alliance has detrimental long run effects for the economy .The study
also reveals that despite the growth experienced overall in the alliance, South Africa’s economic
participation is limited due to unfair trade practices amongst the members of the alliance. The findings
provide an insight of the policies to be adopted to achieve higher growth rates in South Africa within
BRICS alliance.
Keywords: Trade openness, Growth, BRICS, Unit Root, Vector Error Correction Model.
i
CHAPTER ONE
1. INTRODUCTION
1.1. BACK GROUND OF THE STUDY
BRICS, originally "BRIC" before the inclusion of South Africa in 2010, is the title of an association
of emerging national economies: Brazil, Russia, India, China and South Africa. According to the UNRussia report (2012:48) with the possible exception of Russia, the BRICS members are all developing or
newly industrialized countries, but posses’ distinct large, fast-growing economies and high influence on
regional and global affairs. The World Trade Organization(WTO) points out that the five BRICS
countries represent almost 3 billion people about 43% of the world population, with a combined
nominal GDP of US$14.9 trillion, which is about 25% of the world’s GDP and an estimated US$4 trillion
in consolidated foreign reserves and about 11% of the world’s foreign direct investment. Presently, South
Africa holds the chair of the BRICS group.
According to Wilson and Purushotaman (2010), BRICS economies will possibly become world economic
powers in the next 50 years. It is believed that BRICS economies will be larger than the elite group of the
worlds’ six richest nations (G6) economies in US dollar terms in the next 40 years and that by 2025 it will
nearly be half of the G6 countries’ size.
However, Jenkins (2013) argues that this imposes on South African producers the challenge of dealing
with a source of foreign competitiveness that is additional to the productive conditions within each
country in the BRICS. It is further argued that this is arbitrary on South Africa considering that South
Africa has higher trade openness than any of the other BRICS nations yet they make access to their
markets difficult since preference is granted among countries in a given region such as Asia for China
and India, South America for Brazil .These intra-regional preferences are also believed to force South
African exporters to face higher barriers than those imposed on competitors from other countries
(ibid,2013).
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CHAPTER TWO
2.0LITERATURE REVIEW
2.1 INTRODUCTION
2.2.2 Classical economists
According to classical economists, foreign trade promotes growth in two ways. The first implies the
optimal distribution of resources and productivity which leads to higher growth. Secondly countries are
said to have recourse to basic raw inputs and capital goods, which they ordinarily cannot produce. This is
believed to equip them with tools domestic growth.
EMPERICAL LITERATURE
With regards to empirical investigation, empirical studies regarding the link between trade and economic
growth in the BRICS economies are scant. However, there have been some studies conducted to
investigate the contribution of international trade to growth individually in these economies. Significant
though, is the study by Polodoo (2008), who examined the degree to which international trade has
contributed to the economic growth enjoyed by the BRICS economies. The study used panel data from
1990 to 2010 and employs econometric methodologies such as unit root testing and the Vector Auto
regression (VAR) model. The empirical results reveal that international trade has contributed a lot to the
high economic growth rates culminated during the recent decades. However, it also found that
international trade is not the only contributing factor. Human Capital formation (HC), Gross Domestic
Capital Formation (GDFCF) and exchange rate appreciation are equally important contributors.
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CHAPTER THREE
3
METHODOLOGY, ESTIMATION AND INTERPRETATION OF RESULTS
4.6.5.1 Vector Error Correction Model (VECM)
The discovery of a co integration equation in the previous section implies that a VECM can be used. This
allows us to distinguish between the long and short run impacts of variables so as to establish the extent
of influence that changes in independent variables in the BRICS alliance has on South African GDP.
Using the outcomes from the co integration test the VECM shall be specified. The VECM results are
presented in tables’ 11(a) and 11(b).
Table 11(a): Results of the long run co integration equation
Variable
Coeffecient
Standard error
t stat
Consatant
0.264770
SA_GDP(-1)
1.000000
θTO(-1)
-0.514321
0.06822
-7.53877
θNFDI(-1)
0.206023
0.14215
1.44936
θHCF(-1)
70.49986
10.0962
6.98282
θGDP(-1)
0.249736
0.11845
2.10842
θGDCF(-1)
-1.393295
0.20914
-6.66203
θEXCH(-1)
0.049185
0.01068
4.60698
R-squared: 0.588 Adj. R-squared: 0.438; F-statistic: 3.934; Log likelihood:-61.6121.Akaike AIC: 4.556;
SchwarzSC: 4.971Meandependent:-0.0935; S.D.dependent:2.7983
The long run impact of key independent variables on the countries’ economic growth as shown by table
6.0 is illustrated using:
GDPSA=0.26+0.05EXCH-1.39GDCF+70.5HCF+0.21NFDI-0.51TO+0.25GDP (BRICS)...
Equation above suggests that a percentage increase in θ GDP(BRICS) increases GDP of South Africa
by approximately 0.25(ceteris paribus),possibly as a result of “spill-over effects” that come with
globalization. Furthermore, the results suggest that a percentage increase in θ T.O in BRICS alliance
decreases GDP of South by approximately 0.51(ceteris paribus), this long run effect implies that goods
and technology from the BRICS alliance flood domestic markets in South Africa, thus possibly having
lower prices than domestically produced goods as a result of lower production costs and other economies
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of scale and scope in the other BRICS economies. Measures such as tariff and embargoes on South
African products by other BRICS members could also be the cause of this .A percentage increase in θ
NFDI in the alliance increases South African GDP by at least 0.21 which could be a derived benefit from
the foreign investments made by the rest of the world in other BRICS economies. A percentage increase
in θ HCF increases South African GDP by 70.5, which is the largest impact. This could be as a result of
the realization of return on investments in education, health and standards of living in the other BRICS
members, thus increasing their economic active population and productivity which ten benefits South
Africa in the long run. Yet a percentage increase in the θ real effective exchange rate EXCH in the
alliance leads to a 0.26 increase of the South African GDP. This could be as a result of the appreciation
value gained by the alliance currencies against the US dollar, which then benefits South Africa in the long
run.
Table 11(b) Error correction results
Variable
D(SA_GDP)
D(θTO)
D(θNFDI)
D(θHCF)
D(θGDP)
D(θGDCF)
D(θEXCH)
Coeffecient
-0.781125
-0.084654
-0.347221
-0.004747
-0.374162
0.207307
-1.211776
Standard error
0.23434
0.16600
0.23564
0.00157
0.22285
0.09128
1.31734
t-statistic
-3.33335
-0.50996
-1.47350
-3.02026
-1.67897
2.27103
-0.91987
The table above 11(b) shows that the coefficient of D (SA GDP), that is -0.78 shows that the speed of
adjustment is approximately 78 per cent. This implies that if there is a deviation from equilibrium, 78 per
cent is corrected in one year as the variable moves towards restoring equilibrium. Therefore, this means
that there is strong pressure on South African GDP to restore long run equilibrium whenever there is a
disturbance. This speed of adjustment is statistically significant with an absolute t-value of approximately
3.333. The high speed of adjustment by the South African GDP may reflect the existence of some positive
factors affecting GDP in South Africa. These factors include the increase in level of education, positive
changes in demographic factors, ideal monetary and fiscal policies as well as foreign policy, among
others.
On the other hand the coefficient of D(θTO), that is -0.008 shows that the speed of adjustment is
approximately 8 percent. This implies that if there is a deviation from equilibrium, only 8 percent is
corrected in one year as the variable moves towards restoring equilibrium. Therefore this means that there
is no strong pressure on θTO in BRICS to restore long run equilibrium with South African GDP. The
impact of this is that South Africa’s economic growth is being adversely affected both in the short and
long run by the trade openness in the alliance. This implies that South Africa imports more than it exports
to the BRICS, thereby increasing its trade deficits and possibly long term liabilities in terms of balance of
payments with BRICS alliance. Importing of goods could lead the erosion of the domestic markets
specifically when there is trade deficit occurrence i.e. the import is higher than the export. Some of the
goods like cars, textile chicken and appliances that are often imported lead a higher loss of jobs in the
respective markets.
The South African domestic industries can also be crippled due to the imports from BRICS countries
where the wages and other cost of production are generally lower than South Africa’s. This causes
domestic industries not to compete since they cannot lower prices of goods than the cost of goods and
also they have the obligation to the worker union to offer a minimum wage.
5
CONCLUSIONS AND POLICY RECOMMENDATIONS
However it is pointed out that in terms of the balance of trade, South Africa has run a trade surplus with
Russia in the last two years of R1.3 billion and R1 billion respectively, after running trade deficits in 2008
and 2009,whilst South Africa runs a trade rising deficit of nearly $1 billion with Brazil. The country's
biggest trade deficit is with China, a figure that reached a high $4 billion last year(2012).However, after
running trade surpluses with India of R2.5 billion in 2009 and R1.5 billion in 2010, South Africa in 2012
recorded a trade deficit of R4.9 billion with India for example terms of the impact of Chinese competition
on South African manufacturing and industrial employment, one has to consider the share of
Chinese(12%) and other imported products in the total consumption of manufactured goods. The
increased openness of the South African manufacturing sector and the economy as a whole over the past
two decades (1993 to 2013) has exposed it to increases of import penetration which can largely be
attributed to China.
Estimation results revealed that average gross domestic product in the BRICS alliance (θGDP (BRICS)) has
a positive impact on the South African economy. The results also showed that average trade openness in
the alliance (θTO) negatively affects South Africa’s economy. On the other hand the average net foreign
direct investment (θNFDI) in the alliance has a positive impact on the South Africa’s economy, whilst the
average human capital formation (θHCF) and the average real effective exchange rates (θ EXCH) have
positive impact on the South African economy. However, the average gross domestic capital formation
(θGDCF) in the alliance has a negative impact on South Africa’s economy.
4.6.6 Trade and industry policy
The long run equation however suggested that South Africa’s trade openness in the alliance has a negative
impact on South Africa’s economy. However, theory is in not in agreement as to the weather trade
liberalization or trade protectionism promotes or limits economic growth. Using the impact of trade
openness on South Africa’s economy as prescribed by theory as well as the coefficient of trade openness
from the long run equation suggested by VECM results, it implies that a 1 unit rise in θ trade openness
would lead to a 0.51 decrease in the level of economic growth in the South African economy. Therefore,
to improve the South African economy, trade openness in the alliance should be lowered. However, this
remedy is only applicable if all the domestic industry is stimulated and the domestic prices are
competitive and the infant industries are given optimal terms protecting them against foreign
multinationals who already benefit from low production costs, economies of scale and economies of
scope are collectively grouped and treated as an aggregate
Also a significant number of the ten industries with the highest level of Chinese import penetration are
traditional labor intensive sectors such as textiles and clothing, footwear, leather products and furniture.
Chinese competition in these industries therefore likely to have a severe adverse impact on domestic
employment especially of unskilled workers and is likely
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