A Time Series Analysis of the Role of Imports in India's Phenomenal Economic Growth

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Abstract

This paper investigates the role of imports in India's impressive economic growth. Annual data ranging from 1970 to 2005 are used to investigate the impact of imports on economic growth that is measured by the real GDP. Johansen's (1988) cointegration tests indicate that these two variables are cointegrated. Therefore, a long run relationship between imports and the real GDP exists. A vector error correction (VEC) testing framework is used in a further data analysis. VEC tests indicate that imports have impacted positively India's economic growth in the short run. Therefore, imports may have played an important role in India's recent economic growth.

I. INTRODUCTION

India's economy has experienced phenomenal economic growth in recent years. It has become one of the world's fastest growing economies. (1) International trade has undoubtedly played a key role in India's economic growth. India's international trade liberalization policies that started in the early 1990s have led to an unprecedented surge in both exports and imports. Exports increased 320 percent from 1995 to 2005, while during the same time period imports experienced an astonishing 438 percent increase! Throughout the 1970-2005 period, large and ever expanding trade deficits were prevalent in India's economy. (2) Yet throughout the same time span, India's output continued to grow. The traditional view of the relative importance of exports and imports in economic growth cannot provide a satisfactory explanation for India's impressive economic growth. Traditional economic theory asserts that exports impact economic growth positively while imports affect it negatively. This conclusion is self-evident from the treatment of exports and imports in conventional GDP accounting practices. The conventional GDP accounting approach measures the monetary value of all goods and services produced in an economy during a specific period of time. Items that are purchased abroad, i.e., all imports, are subtracted from the overall monetary value of the GDP. All domestically produced goods, including those exported abroad, add to the overall GDP monetary value. Therefore, exports are considered a positive item in the GDP account, while imports reduce its numerical amount. Given this traditional treatment of exports and imports, trade deficits arising from a growing excess of imports over exports are assumed to impact economic growth adversely.

Given the above short discussion of the respective roles of exports and imports in the traditional view of economic growth, it is clear that this approach cannot explain satisfactorily India's recent impressive economic growth. In fact, it appears that the economic growth in India may well have been partly due to an unprecedented increase in India's imports, rather than to a substantially smaller increase in its exports. This assertion has a theoretical basis. Several hypotheses are readily available to explain how imports can impact economic growth positively. First, the basic concept of comparative advantage can explain imports' positive impact on economic growth. International trade that relies on importing those goods that can be produced at lower costs abroad and exporting those goods that are produced more efficiently at home creates wealth in both trading countries. This wealth creation enables more investment to occur in all trading countries. Investment is the key element of economic growth. Therefore, through this channel, imports can cause economic growth in the importing country. Second, import competition can improve the productivity and the efficiency of domestic industries and businesses that face foreign competition. It can also lead to innovation in the importing country. Domestic businesses that operate more efficiently due to the foreign competition produce higher output. In this way, higher domestic economic growth is achieved. Additionally, the financial consequences of trade deficits may have a positive impact on economic growth. …