Trade, Investment and Growth : Nexus, Analysis and Prognosis

This paper looks at the patterns of causation between income, export, import, and investment growth for 39 developing countries. Our approach differs from previous efforts in a number of ways. First, we examine each country individually in order to allow for complete heterogeneity. Second, we apply novel model selection techniques which are based on in-sample goodness-of-fit criteria and ex-ante predictive ability criteria to identify the best model for each country. Our approach allows us to shed new light on at least two issues. First, we look at the incidence of causation and reverse causation between various economic variables which are commonly believed to lead economic growth and find that there is less reverse causation from income to these variables than suggested by the literature. Second, we suggest that there is a missing variable in previous work, namely an index of global business cycle conditions. We find, as expected, that countries with high trade exposure, growth rates, and investment rates tend to gain in predictive ability from the addition of such a variable