1
Chapter 1
Introduction
Time and again, economic growth has been considered as one of the surest signs of a country’s
overall health. As per definition economic growth is a long term expansion of the productive
potential of an economy. While economists, government and individual may all have their own
opinions about what should constitute economic growth, the truth is all of these things working
together help create an overall healthy economy. Without one piece, the entire puzzle may fall
apart.
Unfolding the economy of Mauritius, it can be seen that a lot of development took place for the
past decades. Indeed, the island had witnessed various changes when it comes to the economic
activities. From a mono-crop economy depending mainly on sugar, Mauritius has been
diversified in such a way that it is known worldwide for the services it provides. Indeed,
Mauritius observed an economic growth of -10.1% in the year 1980 while in 2009 the growth
was estimated at 3.1%. This rise in the Gross Domestic Product (GDP) of the country can be
explained by a number of factors.
Some factors such as changes in consumer and business confidence, aggregate demand
conditions and monetary and fiscal policy, tend to have a mainly temporary effect on growth.
Other factors such as unemployment rate and productivity growth have more enduring effects
and help to determine the economy’s average growth rate over a longer period of time.
Using time series data for the Mauritian economy for the period 1976-2009, the relationship of
the determinants of the economic growth shall be modeled. To reiterate further, factors such as
openness, investment, inflation rate, literacy rate and financial intermediation will be considered.
The data will be tested whether in Mauritius context, the relationship of these determinants
mentioned above is significant. Subsequently nominal GDP per capita was used to represent
economic growth, primary enrollment ratio was used to represent literacy rate, GDFCF was used
to represent investment and CPI to represent inflation.
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Below there shall be an analysis of the effects that each factor has on economic growth and their
respective trends throughout the period 1976-2009. Furthermore, various tests will be carried out
to determine the relationship between the independent and the dependent variable and these
include the Link test, a Regression analysis, a Correlation analysis, test for Multicollinearity, and
finally a test for Serial Correlation will be undertaken.
This introduction will be followed by Chapter 2 where past research will be reviewed. Chapter 3
consists of an overview of the Mauritian economy. The methodology will subsequently be
considered in Chapter 4. Chapter 5 consists of the interpretation and analysis part of the model.
The last steps that will be undertaken are the policy implications of the model and finally the
conclusion in Chapter 6.
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Chapter 2
Literature Review and Empirical Evidence
Economists have long been interested in the factors which cause different countries to grow at
different rates and achieve different levels of wealth. This issue is especially relevant today. The
1990 World Bank World Development Report highlights the scale of global poverty and the
importance of economic growth in alleviating poverty. The historical record shows a broad range
of outcomes in achieving su3tained economic growth. Some countries have achieved high
incomes while many remain at lower levels. Determining the reasons for these differences
remains an important theoretical and empirical task. We review recent theoretical advances in
growth theory which are potentially relevant to development policymakers and the existing
empirical literature on the determinants of economic growth.
Data limitations complicate generalizing these findings to periods before the twentieth century
and to geographical areas beyond the United States. However, the rise of modern economic
growth over the last few centuries seems to roughly coincide with the rise of mass schooling
throughout the world. The sustained growth in income per capita evidenced in much of the world
over the past two to two and a half centuries is a marked divergence from previous tendencies.
Bloom and others confirm the findings of Tilak (2003) that one possible channel through which
higher education can enhance economic development in poor/ developing countries is through
technological catch-up. In knowledge economy, tertiary education can help economies gain
ground on more technologically advanced societies as graduates are likely to be more aware of
and better able to use new technologies.
Keynesians postulate that the impact of money in an economy depends the ability of money to
influence interest rate, rate of interest to influence demand for investment fund and for
investment fund to influence national income. In line with this, the Harrod-Dommar postulates
that changes in national income depend linearly on change in capital stock. Investment or change
in capital stock if financed out of domestic savings. In summary the Harrod-Dommar growth
model summaries as follows, economic growth will proceed at the rate which society can
mobilize domestic savings resources coupled with the productivity of the investment (Somoye,
4
2002). The creation of a pool of investment fund is the objective of bank financial
intermediation. Banks through credit creation provide a pool of investment funds for borrowers.
But the ability of banks to create credit to a large extent depends on the development of a
nation’s banking system.
Fischer (1993) results indicate that inflation reduces growth by reducing investment and
productivity growth. He further notes that, low inflation and small fiscal deficits are not
necessary for high growth even over long periods; likewise, high inflation is not consistent with
sustained economic growth. Ghosh and Phillips (1998), using large panel dataset, covering IMF
member countries over 1960 to 1996, found that at very low inflation rates (less than 2-3 per
cent) inflation and growth are positively correlated. However, they are negatively correlated at
high level of inflation. Similarly, the empirical results of Nell (2000) suggest that inflation within
the single-digit zone may be beneficial, while inflation in the double-digit zone appears to
impose slower growth.
International trade indicators can be of two categories: price-based and quantity-based indicators.
The most commonly used measure is the degree of openness which is defined by exports plus
imports divided by GDP
Trade Openness = (Exports + Imports) / GDP
Where X is the value of exports, M is the value of the imports, and the GDP is the total Gross
Domestic Product.
Economic growth is defined by the increase of goods and services produced by the country over
time. It is measured as the percentage of the increase of the real Gross Domestic Products (GDP)
(Sullivan & Steven, 2003). The relationship between globalization and economic growth has
been extensively researched and investigated. Dollar (1992) analyzed the relationship between
economic performance and trade openness, while Frankel and Romer (1996) studied the
relationship between growth and actual trade flows. Their results show that openness and trade
flows are significantly related to the economic growth.
5
Chapter 3
Overview of the Economic Growth history in Mauritius
Despite its several weaknesses, Mauritius has transformed itself from a poor mono-crop
economy into one of the most successful economies in Africa in recent decades. Using
purchasing power parity (PPP) data for 44 Sub-Saharan African countries, Arbache and Page
(2008), for example, examined country-level dynamics of long-run growth between 1975 and
2005 and conclude that Mauritius was one of the best performers, both in terms of per capita
growth performance and in terms of low growth volatility.
Real GDP growth averaged more than 5 percent between 1970 and 2009, while GDP per capita
has increased more than tenfold over the same period. In its heyday in the 1970s, the sugar sector
in Mauritius accounted for close to one-third of employment, one-third of export earnings, and
one-quarter of GDP. Through smart negotiations and building on a preexisting relationship with
the United Kingdom, Mauritius succeeded in obtaining preferential treatment from the European
Economic Community (EEC) through the Sugar Protocol of the Lomé Convention in 1975,
under which it received more or less free access for its sugar exports to the EEC.
In 1970, Mauritius passed the Export Processing Zone Act, which provided powerful incentives
to manufacturers to cater for foreign markets. Key components of the new legislation included
protective import duties and quotas for infant industries, suspension of import duties on materials
and equipment for industrial use rebates of import duties on other raw materials and components
for specified industries, duty drawback schemes, and favorable long-term loans. The granting of
duty-free inputs for manufactured exports was a key policy in expanding Mauritius’ export
competitiveness on world markets, while tax incentives provided to the exporting firms helped
subsidize exports.
Though Mauritius benefited from the sugar protocols, the government also recognized early on
the advantages of diversification. As the sugar and EPZ sectors in Mauritius struggled, the
tourism sector has expanded rapidly; according to the Mauritius Chamber of Commerce, tourist
arrivals reached 240,000 in 1988, 400,000 in 2000, and 900,000 in 2008.
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Efforts at economic diversification have been successful, allowing the country to move from
sugar to textiles to a broader service economy, embracing new sectors, particularly light
manufacturing, offshore banking and financial services, and service-related information and
communication technology (ICT). Development of the information technology sector was
intended to transform Mauritius into a “cyber-island” by creating a high-tech multi-storeyed
tower with strong technological capabilities that provides a home to companies from all over the
world to set up operations, manage data, facilitate e-commerce, and establish call centers.
Though a variety of explanations have been developed to explain Mauritius’ growth
performance, there is no doubt that the country’s focus on international trade has been a critical
element of that performance; open trade policies have been important in sustaining growth.
Simultaneously, Mauritius pursued a very liberal investment regime and used incentives to
attract foreign direct investments (FDI). The island has also developed a plethora of strong
institutions and good governance.
Fiscal policy in Mauritius has focused on ensuring that spending remains linked to the resource
availability. On the other hand, monetary policy has helped anchor economic growth and ensured
competitiveness. Since its creation in 1967, the Bank of Mauritius has been concerned with
ensuring the competitiveness of the country’s export sectors and, secondly, with price stability.
Furthermore, another major reason for Mauritius’ economic success has been its business climate
and incentives for foreign companies to locate therein. Mauritius has no capital controls, a
relatively stable currency, a low flat corporate tax rate of 15 percent, and a large number of
double taxation avoidance agreements; together, these attributes sometimes make Mauritius
more attractive than larger financial sectors for businesses. The World Bank’s Doing Business
2010 ranks Mauritius as the best country in which to do business in Africa. Overall, Mauritius is
ranked 17th out of 183 countries ranked in the 2010 survey.
During and in the aftermath of the biggest exogenous shocks to its economy in recent times—the
phasing out of the Multifibre Arrangement governing textiles, significant reductions in EU sugar
protocol prices, the 2008 food and fuel crisis, and the 2008–09 global financial crisis—
Mauritius’s economy has displayed strong resilience. Morisset, Bastos, and Rojid (2010) find
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that the country’s resilience to the shocks was a combination of four factors: reforms to sustain
long-term growth, which accelerated in 2006; timely, targeted, and temporary short-term
response to the crisis; institutional arrangements to face the crisis that promoted private sector
collaboration; and strong relationships.
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Chapter 4
METHODOLOGY
In this assignment, the effect of the above mentioned macroeconomic factors on the economic
growth of Mauritius will be tested. In this context, a very simple economics function has been
adopted as follows:
Economic growth = f (literacy rate, financial intermediation, inflation, trade
openness, GDFCF)
For analytical purposes and to conduct various tests using STATA, we have transformed the
function into an econometric model which can be described as follows:
Lngdp = α + β1lnlit+ β2lnfin + β3lninfl + β4lnopen + β5lngdfcf + ut
Where the dependent variable is economic growth (GDP) and the explanatory variables are the
constant (α), the literacy rate(β1), financial intermediation (β2), inflation (β3), trade openness (β4)
and investment (β 5) and µt, the error term.
I. Model Used: Log-Log
The Log-Log model has been used for its simplicity and ease of analysis. Indeed, it measures the
percentage change of economic growth (Y variable) given a percentage change in the
macroeconomic factors(X variables). The slope coefficients on the other hand assess the
elasticity of economic growth in respect with the other macroeconomic determinants.
The table below illustrates the variables used and how they have been measured.
Variables Proxy How measured
Lngdp Economic growth Nominal GDP per capita
Lnlit Literacy Rate Primary enrolment ratio
Lngdfcf Investment Gross domestic fixed capital
formation ( as a % of GDP)
LnOpen Openness Openness Index
Lnfin Financial intermediation Financial intermediation (in
RsM) as a % GDP
Lninfl Inflation CPI as a % GDP
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The primary data has been obtained from the Central Statistics Office annual report for period’s
1976 to2009 and IMF. Based on the data collected, the relationship which exists between the
values of the aforesaid macroeconomic variables and the economic growth of Mauritius will be
determined by using regression analysis. The result will enable in validating one of these
hypothesis:
H0: Null hypothesis – the values of each macroeconomic factor is not related to the economic
growth of Mauritius.
H1: Alternate hypothesis- the values of each macroeconomic factor is related at any point to the
economic growth of Mauritius.
ASSUMPTIONS:
» Over the periods all Government expenditure that inject into the economy are held
constant.
» Activities of other financial institution in the economy are held constant.
» Monetary/legal policies over these periods are uniform.
II. Testing for stationarity
To prevent spurious regression, it is vital to test for stationarity. The economic variables are
initially expected to be non-stationary- I(1). The latter have therefore been subject to the
Augmented Dickey-Fuller (ADF) test, after determining the optimal number of lags that should
be used.
Ho: variable is non-stationary
H1: variable is stationary
The null hypothesis about the unit root is rejected if the variable is I(0) and will not be rejected if
it is assumed to be non-stationary[I(1)].
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III. Testing for stationarity after first differences
If in step 1, the data is I(1), meaning that if there is indication of non-stationary series, to avoid
spurious regression, we have to transform the non-stationary series to make them stationary. In
such cases, ADF test has to be run on the first difference of the original time series. By so doing,
the null hypothesis will be rejected and hence can be concluded that the data becomes I (0).
IV. Establishing the long run relationship
In this stage, the cointegrating regression is estimated using the Ordinary least squares (OLS)
approach, and generate the long run relationship as follows:
Lngdp = α + β1lnlit+ β2lnfin + β3lninfl + β4lnopen + β5lngdfcf + ut
V. Testing for stationarity for the unit roots of the residuals
The regression residuals are then saved and an ADF test has been carried out on them. The
residuals are expected to be stationary (I (O)) to conclude that the variables are cointegrated.
VI. Error Correction Model
If the variables are cointegrated, then we use the residuals obtained in step 1 to build up the error
correction model. This mechanism corrects for disequilibrium and will create the following
short run equation:
∆ gdpt = β1∆lnlitt + β2∆linfint + β3∆lninflt + β4∆lnopent+ β5∆lngdfcft + α4ût-1 + vt
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Chapter 5
Data Presentation, Regression Analysis and Interpretation
5.1 Analysis of Data
A. Literacy Rate
In economics, the literacy rate is the proportion of the population over age fifteen that can read
and write.
The highest value of public spending on education over the past 29 years was 5.84 in 1980, thus
explaining the increase in enrollment for primary education in the following three years. The
government has made an effort to provide adequate funding for education, occasionally straining
tight budgets. In 1991-92, reflecting the trend of earlier budgets, the government allocated 13
percent for education, culture and art. Nonetheless, facilities in rural areas tended to be less
adequate than those in Port Louis and other cities. Literacy in 1990 for the population over
fifteen years of age on the island of Mauritius was 80 percent overall, 85 percent for males, and
75 percent for females. The year 1993 marked the advent of the Basic compulsory education law
which caused a drastic fall in child labour and an increase in the enrollment rate in secondary
education.
According to the new educational reform, introduced by the new government who came into
power in 2000, and the regionalisation, four educational zones were created. This new
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development also had a positive impact as children who previously could not attend school due
to traveling expenses would now be able to as their assigned school would be closer to them.
Due to the competition and the ranking system at CPE there was a substantial amount of failures
which resulted in the fact that 50% were excluded from secondary education some ten years ago
and consequently when the ranking system was abolished in 2002, there was a positive impact on
the enrollment rate in secondary education. In 2005, there was the amendment of the Education
Act which stated that education was compulsory up until the age of 16. This further caused a fall
in the dropout rate and an increase in enrollment both primary and secondary education
B. Financial Intermediation
Over the past few years, Mauritius has carved out a comfortable niche in the world of
international financial services due to its expanding tax treaty network, a reputable offshore
jurisdiction, its strategic location between the Far East and the European time zones, and its
membership of major regional trading blocs such as the SADC and the COMESA. Financial
Intermediation, led by offshore banking, is the fourth pillar of the economy.
The sector is expected to grow at an annual average rate exceeding 5% over the years to come. It
currently consists of a number of key components including banking, global business, insurance
& re insurance, capital markets, international legal services and other non-banking financial
intermediaries. The Stock Exchange of Mauritius (SEM) was set up in 1989 and is today
renowned as one of the leading exchanges in Africa. Since 1989 annualised total return of 17.3
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% in USD terms supported by compelling incentives in the form of no withholding taxes on
dividends and no taxes on capital gains, have attracted strong foreign investment inflows on
many listed companies.
In the early 1990s, the then newly launched global business sector, supported by a growing
banking sector and a profitable Stock Exchange, gave a strong boost to the Mauritius
International Financial Centre (MIFC). The official launch of the Mauritius offshore centre was
carried out in 1992. The new millennium brought in a plethora of laws such as the Trust Act
2001, Financial Intelligence Act and AML Act 2002 which will help in preventing money
laundering activities. This subsequently led to the sector’s growth by 14.6 per cent in 2000 and
13.5 per cent in 2001. The OECD classified Mauritius in 2009 as a jurisdiction which has
implemented internationally agreed tax and transparency standards. Investors’ confidence and
trust in Maritius as an international financial center has increased, thus allowing for more use of
the platform by the international business community. However in that same year, the rate of real
growth for the financial intermediation sector has slowed sharply in 2009 due to the global
economic downturn In 2010, the Mauritius Financial Services Commission had registered more
than 25 000 global business companies and around 750 global funds.
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C. Inflation
Inflation is a condition, when cost of services coupled with goods rise and the entire economy
seems to go haywire. Inflation has never done good to the economy. Inflation can lead to
uncertainty about the future profitability of investment projects.
The second oil crisis in 1979 which led to 100% increase in the prices of petroleum products, hit
the world and Mauritius and unfortunately there was no corresponding increase in sugar prices to
cushion the damaging economic and financial effects of this second oil price shock. Furthermore
the rate of inflation which was 42% in 1980 was mainly due to the first rupee devaluation
coupled with the after effects of the 1979 rise in petroleum prices and subsequently fell to 14.5%
in 1981 and 5.6% in 1983. In 1983, a new sales tax at the rate of 5% was introduced for the first
time in the economy and this explains why the inflation rate rose from 5.6% to 7.3% as
Mauritians had to pay a higher price to buy the same goods and they may even have been
hoarding certain staple goods just before the implementation of the sales tax thus causing a more
rapid rise in prices.
In 1991, nearly 300,000 tourists visited the island, creating in its wake much employment and
bringing into the country substantial foreign exchange as gross earnings reached the level of Rs.4
billion. With the advent of tight labour markets, inflation had again made its appearance on the
economic scene, reaching double-digit figures in 1989 and 1990 although it had been brought
down to 7% in 1991. The introduction of the VAT in 1998 explains the slight increase in the
inflation rate. The increase in the VAT in 2001 led to a subsequent rise in energy prices and
15
utilities and thus causing a rise in the inflation rate. In the wake of the mid-2006 liberalization,
major price increases were observed for a large number of goods including food, soft drinks,
cigarettes, and alcoholic beverages. The price of government imported flour and kerosene almost
doubled, while that of items such as bread, rice, diesel oil, and gasoline rose by around 50
percent. The advent of the 2008 economic meltdown did nothing to improve the situation with
the inflation rate continuing to increase.
D. Trade Openness Ratio
Using time series data for the Mauritian economy from 1976 to 2009, we have noticed the
complex relationship between the trade openness ratio and economic growth.
An analysis of local trade openness ratio reveals that there has been a significant increase from
97.97 in 1976 to 133.99 in 2009.The trade openness ratio has reduced by 5.99% between 1976
and 1979. This is due to the Mauritian economic deterioration in the late 1970s. Petroleum prices
rose, the sugar boom ended, and the balance of payments deficit steadily rose as imports
outpaced exports. There has been a rise of 33.46% in trade openness ratio between 1980 and
1990. In 1986 Mauritius had its first trade surplus in twelve years. This good performance can be
explained by the elimination of the quantitative restrictions in Mauritius. Price controls were
lifted on most items and the export tax on sugar was reduced. The early 1990s witnessed a
removal of import licensing for the majority of products and a liberalization of the credit policy.
Mauritian trade policies have grown extensively less restrictive and less discriminatory. The
16
trade openness ratio was also affected by Europe’s common agricultural policy and the potential
effects on textiles of the General Agreement on Tariffs and Trade (GATT).
Mauritius’ trade openness ratio dropped slightly from an average rate of 1.04 over the 2005-07
periods to 0.93 in 2008. Export growth decelerated marginally in 2008 relative to 2005-07, from
5.9% to 5.4%, but import experienced a steeper decline, going from 6.5% to 2.9%. Exports were
hurt by little growth in the textile sector (a major export sector) owing to reduced consumer
demand in their main EU (primarily the UK) and U.S. markets following the global financial
crisis, and a fall in sugar exports. Tourism, which accounted for 55% of services exports in 2007,
also exhibited weak performance in 2008 as a result of a decline in tourist arrivals due to the
global economic downturn. As illustrated in the graph above, trade openness ratio was at its
highest point, amounting to 168.55 in 2006 followed by a continuous slowdown till 2009.
E. Investment
Economic theory reveals that there is a direct relationship between GDFCF and GDP. This
relationship further stresses the importance of investment to the economy. As shown below, alike
any other component of the economic growth it is subject to violent fluctuations.
An analysis of local GDFCF as a percentage of GDP reveals that there has been a significant
decreased significantly from 30.90 in 1976 to 21.54 in 1984. The ratio has slightly increased by
4.27% from 1976 to 1978 which slumped continuously till 1984. There has then been a sharp
increase of 55.77% between 1987 and 1994. This upward trend can be explained by the growth
of 18% in investment in machinery and equipment. In addition, there was a rise in buildings and
17
construction work. The GDFCF ratio had declined to 22.94% in 2000 and this is partly due to the
fall amounting to 5.8% in investment in the EPZ. This situation coincides to some extent with the
persistent weakness of the euro which has compounded the existing financial duress of less
performing firms already weakened by rising unit labor costs. Although the subdued investment
level can partly be attributable to some exogenous factors, it is equally true that business
confidence has not as yet fully recovered. . As for 2007, the GDFCF ratio amounting to 25.10 is
largely attributable to the investment by the government, particularly in the education sector
5.2 Summary of Data
Variable Obs Mean Std.Dev. Min Max year 34 1992.5 9.958246 1976 2009
lngdp 34 10.61824 1.147958 8.557526 12.29246
lnlit 34 4.656358 .0368989 4.589581 4.744133
lnfin 34 1.842316 .4202326 1.267164 2.575689
lninfl 34 .9407482 .4135601 .3179288 1.566017
lnopen 34 4.855539 .1864807 4.522837 5.127262
lngdfcf 34 3.791176 .5500841 2.82 4.92
The above represents data for 34 consecutive years starting from 1976 to 2009. For each of the
variables the following can be observed:
DEPENDENT VARIABLE
Economic Growth ( GDP)
Over the last 34 years it has been observed that the lowest value for economic growth
was registered in 1980 and the highest value was in 2009. The mean value was found to
be 10.61824 and it has been observed that there was a diversion of +1.147958 from the
mean value.
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Independent variable
Literacy Rate
Over the period of observation it has been seen that the lowest value for literacy rate was
registered in 2007 and 2008 and the highest value was in 1982. The mean value was
found to be 4.656358 and it has been observed that there was a diversion of +0.0368989
from the mean value.
Financial intermediation
Over the period of observation it has been seen that the lowest value for financial
intermediation was registered in 1976 and the highest value was in 2009. The mean value
was found to be 1.842316 and it has been observed that there was a diversion of
+0.4202326 from the mean value.
Inflation
Over the period of observation it has been seen that the lowest value for inflation was
registered in 2008 and the highest value was in 1981. The mean value was found to be
0.9407482 and it has been observed that there was a diversion of +0.4135601 from the
mean value.
Openness
From 1976 to 2009 it has been observed that the lowest value for openess was registered
in 1979 and the highest value was in 2006. The mean value was found to be 4.855539
and it has been observed that there was a diversion of +0.1864807 from the mean value.
Investment (Gross domestic fixed capital formation)
From 1976 to 2009 it has been observed that the lowest value for investment was
registered in 1987 and the highest value was in 1978. The mean value was found to be
3.791176 and it has been observed that there was a diversion of +0.5500841 from the
mean value.
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5.3 Tests for Model Specification
SOURCE SS DF MS NUMBER OF OBS = 34
Model 42.6132162 2 21.3066081 F( 2, 31) = 755.35
Residual 0.874432449 31 0.028207498 Prob > F = 0.0000
Total 43.4876487 33 1.31780754 R-squared = 0.9799
Adj R-squared = 0.9786
Root MSE = 0.16795
lngdp Coef. Std. Err. t P> ǀtǀ [95% Conf. Interval]
_hat 1.806359 0.5994913 3.01 0.005 0.5836885 3.02903
_hatsq -0.0382683 0.0284245 -1.35 0.188 -0.0962404 0.0197038
_cons -4.199576 3.1314 -1.34 0.190 -10.58611 2.186957
The linktest can be used to detect a specification error in a sample. The idea behind linktest is
that if the model is properly specified, one should not be able to find any additional predictors
that are statistically significant except by chance. The variable _hat should be a statistically
significant predictor, since it is the predicted value from the model. This will be the case unless
the model is completely misspecified.
On the other hand, the variable _hatsq is insignificant as p-value is greater than 0.05(p-
value=0.188), i.e. the linktest is insignificant. This means that there is no omission of relevant
variable(s) and the function has been correctly specified.
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5.4 Stationarity of variables
Augmented Dickey Fuller (ADF) Test
NON-STATIONARY VARIABLES AFTER FIRST DIFFERENCE
VARIABLES P-VALUE VARIABLES P-VALUE CONCLUSION
gdp 0.0668 gdp 0.00321 I(1)
lit 0.4305 lit 0.05310 I(1)
fin 0.9374 fin 0.0004 I(1)
infl 0.8882 infl 0.0209 I(1)
open 0.4462 open 0.0042 I(1)
gdfcf 0.3672 gdfcf 0.0023 I(1)
The ADF test which was carried out at a 90% confidence level to test for stationarity on the
individual variables mentioned above in the table. It has been assumed that if the p-value is less
than 0.05, then the variables will be considered to be stationary.
Therefore, from the above table, we can see that all the variables were at first non-stationary. The
non-stationary time series was transformed by taking their first difference, we conclude that the
first-differenced time series data are stationary of order 1.
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5.5 Cointegrating Relationship (Long Run Relationship)
Variables Coefficient P value Beta Adjusted R2
97.49 % Lnlit 8.413385 0.000 0.2704321
Lnfin 0.5270708 0.021 0.1929446
Lninfl -2.067108 0.000 -0.7446904 No=34
LnOpen 1.3442661 0.003 0.2181092
Lnfgdfcf 0.3392551 0.000 0.1625659
Lngdp = 8.413385Lnlit +0.5270708Lnfin – 2.067108Lninfl + 1.3444661Lnopen
+ 0.3392551Lngdfcf + ut
The table above is the analysis of variance from the regression viewpoint. It demonstrates a
decomposition of the total sum of squares of the dependent variable. The total variance is
partitioned into the variance which can be explained by the independent variables (Model) and
the variance which is not explained by the independent variables (Residual, sometimes called
Error).
R-squared - R-Squared is the proportion of variance in the dependent variable (lngdp)
which can be explained by the independent variables (trade openness, investment,
literacy rate, inflation, financial intermediation). This is an overall measure of the
strength of association and does not reflect the extent to which any particular
independent variable is associated with the dependent variable. In this case the model
explains 97.87% of the variance in Ln GDP. The R-squared is relatively high since it is
greater than 0.8.
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P-value
The P value is referred as significance level of 5%. In this case all variables have a significant
impact on LnGDP since they are inferior to 0.05.It must be noted that the size of the P value of t-
statistics says nothing about the size of the effect that variable is having on a dependent variable
- it is possible to have a highly significant result (very small P-value) for a miniscule effect.
95% Confidence Interval
We can be 95% confident that the real, underlying value of the coefficient that we are estimating
falls somewhere in that 95% confidence interval, so if the interval does not contain 0, your P
value will be .05 or less. For instance, none of our variables have a confidence interval
containing 0 and consequently their P value is less than 0.05.
Coefficient
The coefficient tells you how much the dependent variable is expected to increase when that
independent variable increases by one, holding all the other independent variables constant.
The coefficient of literacy rate (β1) is 8.41. This illustrates a direct positive relationship between
the level of economic growth and literacy rate whereby 1% increases in the level of education in
Mauritius will expand the level of economic growth by 8.41%.
The coefficient of financial intermediation (β2) is 0.52. It can be inferred that the link between
financial intermediation and economic growth in Mauritius is a positive one. Thus, 1% rise in the
financial intermediation ratio will result in an increase of 0.52% in economic growth. This can be
backed by the fact that Mauritius is having a blooming financial sector.
The coefficient of inflation (β3) is -2.07. This shows a negative relationship between inflation
rate and economic growth implying any decrease in inflation rate will have a positive impact on
the level of economic growth. This is asserted by various economics theories. For instance,
according to the Philips curve, there is an indirect relationship between inflation and
unemployment. Thus, an increase in rate of inflation will cause a decrease in unemployment
23
resulting to an increase in economic growth. In other words, there exists a direct relationship
between inflation rate and economic growth in accordance to economic theories.
The coefficient of openness (β4) is 1.34. This means that there is a positive relationship between
economic growth and openness. Hence, an increase of 1% in openness, holding other variables
constant will result to a rise of 1.34% in economic growth.
The coefficient of GDFCF (β5) is 0.34. In this case as well there exists a positive relationship
between economic growth and literacy rate. Thus, a rise of 1% in GDFCF will lead to an
increase of 0.34% in economic growth.
5.5 Cointegration (Testing for residuals to be stationary)
Consider the following regression:
Lngdp = 8.413385Lnlit +0.5270708Lnfin – 2.067108Lninfl + 1.3444661Lnopen +
0.3392551Lngdfcf + ut
where Lngdp, Lnlit, Lnfin, Lninfl, Lnopen and Lngdfcf are I(1). We can write the above equation as
follows:
ut = Lngdp – 8.413385Lnlit – 0.5270708Lnfin + 2.067108Lninfl – 1.3444661Lnopen - 0.3392551Lngdfcf ---
---------------- Equation (1)
After saving the estimated residuals from the cointegrating regression, firstly the optimal number
of lags has been determined so as to perform the Augmented Dickey Fuller test in order to test
for stationarity of the residuals.
24
Optimum Number of lags
Optimum Lags for residuals
Sample: 1980-2009 Observation:
30
Lag LL LR df p FPE AIC HQIC SBIC
0 21.2907 0.015138 -1.35271 -1.33777 -1.30601
1 29.9084 17.235 1 0.000 0.009111 -1.86056 -1.83068 -1.76715
2 36.1867 12.557* 1 0.000 0.006412* -2.21245* -2.16762* -2.07233*
3 36.1906 0.00776 1 0.930 0.006858 -2.14604 -2.08627 -1.95921
From the above table, it has been estimated that the number of lag to be used to test stationarity
of the residuals to be zero.
Testing for stationarity of the residuals
ADF test on residuals
Variables p-value Conclusion
R 0.0005 I(0)
After running the unit root test, it has been found that ut is I(0) that is they are stationary.
Therefore, although Lngdp, Lnlit, Lnfin, Lninfl, Lnopen and Lngdfcf are I(1), their linear
combination that is Equation (1) above is I(0), and it can be concluded that there is a
cointegrating relationship between the variables.
25
5.6 Error Correction Model (ECM)
It has just been shown that gdp, lit, lit, fin, infl, open and gdfcf are cointegrated; that is there is a
long term or equilibrium relationship between the variables. In the short run there may be
disequilibrium. Therefore, on e can treat the error term in Equation 1 as the ‘’equilibrium error’’.
This error term can be used in the short run behavior of of gdp to its long run vale. The Error
Correction Model (ECM)[Engel & Granger Approach] corrects for disequilibrium. If variables
are cointegrated, then the relationship between them can be expressed as an ECM. In our model,
this will be represented as follows:
∆ gdpt = β1∆lnlitt + β2∆linfint + β3∆lninflt + β4∆lnopent+ β5∆lngdfcft + α4ût-1 + vt
Where, ∆ denotes the first difference operator
vt is a random error term
Using Stata, we have generated a regression of the above model using,
i. Linear Regression
ii. Prais-Winsten Regression
i. Linear Regression(short run)
ût-1 = gdpt-1 - 0.4902289 lnlitt-1 - 0.018698 lnfint-1 + 0.2152635 lninflt-1 -0.0898744 lnopent-1 - -
0.0162135 lngdfcft-1 ; that is, the one period lagged value of the error term from the
cointegrating regression.
ii. Prais-Winsten Regression-The Durbin-Watson (d) resulted as follows:
Durbin-Watson statistic (original): 1.818886
Durbin-Watson statistic (transformed): 1.89903
Since d is closer to 2 in the second case (transformed), the Prais-Winsten Regression model will
therefore be interpreted for our model.
26
REGRESSION COEFFICIENTS FROM ANOVA TABLE
Variables Coefficients p-value Number of observations = 32
Lnlit 0.4874272 0.050 F(6,26) = 0.56
Lnfin 0.0281949 0.394 Prob > F = 0.0000
Lninfl -0.419384 0.000 R-squared = 0.6253
Lnopen 0.774905 0.176 Adj R-squared = 0.5559
Lngdfcf 0.143098 0.149 Root MSE = 0.02275
ût-1 -0.0632752 0.0072
Therefore the short run equation summarises to:
∆ gdpt = 0.0.4874272 ∆lnlitt + 0.0281949 ∆lnfint - 0.419384 ∆lninflt + 0.774905∆lnopent
+0.143098∆lngdfcft -0.0632752 ût-1 + vt ------ Equation 2
From above, it can be concluded that the model is overall significant given a p-value 0.0032
which is less than 0.1 (10% significance level) and also may be said to be a good fit given an
adjusted R2
of 0.6253 which is relatively high. The model has been regressed using first
differences [I(0) series] so there is no such risk as spurious correlation occurring as a result of
non-stationary series.
Moreover, from the above it can be seen that in the short run there are only 2 variables which
GDP. These are literacy rate and inflation since there p-values are less than 0.1.
Hence, it is concluded that the model does not suffer from any autocorrelation. This means that
the error terms associated with observations of different time periods are not related or are
independent of each other. This also satisfies the assumption of the OLS estimator that E (ut) = 0
and COV (ui uj, xi xj) = 0
27
The graph below shows that the error terms are independent upon time, that is, the absence of
autocorrelation.
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
0.3
0.4
1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Residual, u
Residual, u
28
5.7 Correlation Analysis
Correlation is a measure that determines the degree to which two variables’ movements are
associated. It measures the direction and strength of the linear relationship which exists between
two random variables and can take both positive and negative values. Moreover, the correlation
coefficient can also be zero which indicates no relationship exists between the two variables. A
positive one illustrates perfect direct relationship and a negative one shows an inverse
relationship.
Variable Literacy
Rate
Financial
Intermediation
Inflation Openness Investment
Literacy rate 1 Negative Positive Negative Negative
Financial
Intermediation
Negative 1
Negative Positive Positive
Inflation Positive Negative 1 Negative
Negative
Openness Negative Positive Negative 1
Positive
Investment Negative Positive Negative Positive 1
From the above table, it can be inferred that the correlation coefficient among most of the
variables are negative. This implies that some variables have a perfect inverse relationship with
the others. For instance, as the level of inflation falls, a rise in investment is expected and vice
versa.
On the other hand, certain variables have a positive correlation coefficient, it can be implied that
the variables have a direct relationship and move in the same direction. For example, from the
above analysis, we conclude that as the level of financial intermediation rises, the level of
investment also rises.
29
5.8 Test for Multicollinearity
Interconnectedness of independent variables is an important issue when considering models.
Often variables are so highly correlated with each other that it is difficult to come up with
reliable estimates of their individual regression coefficients and such a problem is referred to as
Multicollinearity. A high correlation proves to be a problem to determine the true relationship
between the independent variables. Thus, the Variance Inflation Factor (VIF) test will be used to
test for the presence of Multicollinearity between explanatory variables.
Long Run Short Run
Variables VIF 1/VIF Variables VIF 1/VIF
lninfl 14.47 0.069105 lninfl 14.3 0.069930
lnfin 8.24 0.121316 lnfin 7.95 0.125786
lnopen 6.10 0.164043 lnopen 5.12 0.195313
lnlit 2.85 0.350433 lnlit 2.05 0.487805
lngdfcf 1.57 0.636186 lngdfcf 1.03 0.970204
Mean VIF 6.646 Mean VIF 6.09
An ideal VIF is to ensure that the problem of Multicollinearity should be less than 10 or a
tolerance of less than 0.1. From the VIF test above, it can be concluded that the independent
variables of the model are not linearly dependent since the VIF is 6.65 which is below 10 in
average. This illustrates that the extent of interconnectedness between variables is to a lesser
extent. This means that the independent variables used are not linearly dependent, neither in the
short run nor in the long run. The model used is therefore reliable.
30
Chapter 6
A. POLICY IMPLICATIONS
It can be seen that all the determinants of economic growth are statistically and economically
significant and as a result it can be seen that they all have certain policy implications which can
be implemented in the context of Mauritius.
The direct positive relationship with economic growth implies that much emphasis must be given
to literacy rate. Due to free education and other facilities Mauritius has made a lot of progress in
the educational sector and as such the government as well as the private sector can contribute to
improve the quality of the labour force so as to make it up to international standards. Investment
in education should take place at all levels, formal and non-formal. Non-formal education is an
important area for further investment. However, basic skills programmes should complement,
rather than replace, funding for formal education.
As the level of financial intermediation increases this causes economic growth to move in the
same direction. Aggressive monetary policy can help in mitigating the negative impact of shocks
to banking sector in line with recent economic disturbances. Monetary and macro prudential
policies should closely co-operate. Moreover, the benefits of macro prudential policy can be
sizeable when an economy is hit by financial shocks. Thus macro prudential policy can be
effective in leaning against financial cycles.
The negative relationship between inflation rate and economic growth will in the long run
hamper the economic prosperity of the island and as such certain remedial measures need to be
adopted. Labour market reforms can be adopted so as to nip the problem at the bud and thus try
to decrease cost push inflationary pressures. Furthermore, fiscal policies may be reinforced such
as an increase in the direct taxes or even a reduction in government spending or in government
borrowing.
The positive relationship between trade openness and economic growth can be further sustained
if Mauritius consolidates new trade agreements with other countries than the EU and the African
countries as these countries have exhausted most of their potential. In addition, there needs to be
more bilateral tax treaties amongst countries to help boost the trade openness ratio.
31
The investment of Mauritius increases with its economic growth. Investment has got to be
carried out strategically so as to make the most of the expenditure. Investment has got to be
carried out in such a way so as to create value. Investment in infrastructure and in the
improvement of the transportation sector is important so as to give Mauritius a certain
competitive edge.
B. Conclusion
The sample data chosen was used to carry out analysis. Multiple regression was constructed to
determine whether the macro economic factors really have an impact on economic growth. After
the regression, it was asserted that the Mauritian economy is representative of economic theories
relating to economic growth and other macroeconomic factors. The H0 that states the values of
each macroeconomic factor are not related to the economy has been rejected as the p-value of all
coefficients of various variables are significant.
Various tests have been performed such as the Test for Model Specification, Test for
Multicollinearity, the Shapiro Wilk Test, test for Heteroscedasticity and Serial Correlation test to
strengthen the above mentioned hypothesis. The model is shown shown below:
Lngdp = α + 8.4134Lnlit+ 0.5271Lnfin -2.0671Lninfl + 1.3427Lnopen + 0.3393Lngdfcf + ut
Thus using STATA, it has been confirmed that the data model opted is relevant. However, it is to
be noted that in reality there are other economic and non economic factors which impact on
economic growth.
32
References:
Book: Gujarati, Basic Econometrics, 4th Edition
Report: Mauritius. Bank of Mauritius- Annual report, 30 June 2011
Journals and Working Papers:
Helen V. Milner and Keiko Kutoba (Winter, 2005). ‘Why the move to Free Trade? Democracy and Trade Policy in the Developing Countries’ International Organization, 59(1): 107-143
Ricardo Hausmann, Lant Pritchett, Dani Rodrik (Dec 2005). ‘Growth Accelerations’ Journal of Economic Growth, 10(4): 303-329
Anupam Basu, Evangelos A. Calamitsis, Dhaneshwar Ghura (Aug 2010). ‘Promoting Growth in Sub-Saharan Africa’ International Monetary Fund
Cesar calderon, Norman Loayza, Klaus Schmidt-Hebbel (October 2005). ‘Does Openness imply greater Exposure’ World Bank Policy Research Working Paper 3733
Ali Zafar (January 2011). ‘Mauritius: An Economic Success Story’
Arvind Subramanian and Devesh Roy (August 2001). ‘Who can Explain the Mauritian Miracle: Meade, Romer, Sachs, or Rodrik?’ International Monetary Fund working Paper
Data source:
International Monetary Fund - http://www.imf.org/external/index.htm
World Bank - http://www.worldbank.org/
Stata -http://data.princeton.edu/stata/Introduction.html
-http://www.stasoft.com
33
Appendix
year lngdp lnlit lnfin Lninfl lnopen lngdfcf
1976 8.557526 4.664148 1.515704 1.469506 4.58464 2.92
1977 8.687454 4.677786 1.360134 1.431145 4.598897 2.99
1978 8.810431 4.704891 1.347698 1.408961 4.524136 3.08
1979 8.993998 4.676577 1.267164 1.302545 4.522837 3.24
1980 9.105285 4.683409 1.416088 1.476237 4.689207 3.45
1981 9.250756 4.725658 1.422839 1.566017 4.584557 3.58
1982 9.376986 4.744133 1.412333 1.565541 4.5685 3.88
1983 9.452616 4.725124 1.425431 1.561248 4.541208 3.93
1984 9.560055 4.670934 1.425238 1.508301 4.624187 4.01
1985 9.697922 4.666276 1.391884 1.450153 4.711192 4.05
1986 9.860409 4.670079 1.371479 1.329691 4.767187 4.92
1987 10.05957 4.639958 1.758632 1.137548 4.88022 4.34
1988 10.22173 4.593254 1.822412 0.990226 4.94323 4.34
1989 10.36254 4.589581 1.928331 0.997931 4.960684 4.17
1990 10.52542 4.638028 1.488278 0.93663 4.977911 4.22
1991 10.64033 4.660238 1.519829 0.942216 4.922571 4.34
1992 10.74215 4.670822 1.63595 0.867994 4.884025 2.82
1993 10.86806 4.677964 1.631442 0.827351 4.901383 2.93
1994 10.95809 4.679216 1.767647 0.827152 4.912597 2.94
1995 11.04408 4.675155 1.864453 0.800375 4.901004 3.28
1996 11.15592 4.673742 1.848337 0.744916 4.976817 3.34
1997 11.24902 4.666709 1.914302 0.727895 4.988568 3.39
1998 11.36442 4.658324 2.025944 0.665038 5.033233 3.63
1999 11.42895 4.650421 2.146015 0.676584 5.039521 3.52
2000 11.5261 4.648338 2.304888 0.63104 4.986422 3.79
2001 11.6092 4.633611 2.235769 0.591004 5.057587 3.88
2002 11.67598 4.631382 2.289584 0.585342 4.985983 3.99
2003 11.76511 4.624568 2.374616 0.545952 4.914929 4.04
2004 11.86595 4.620485 2.346687 0.483447 4.914234 4.19
2005 11.91203 4.621935 2.420246 0.491829 5.051966 4.24
2006 12.01169 4.616816 2.437744 0.44191 5.127262 4.22
2007 12.13878 4.609041 2.447154 0.326734 5.08149 4.31
2008 12.24924 4.612459 2.49882 0.317929 5.032352 4.44
2009 12.29246 4.61512 2.575689 0.359054 4.89778 4.49
34
Commands in STATA
summarise
linktest
tsset year, yearly
varsoc lngdp
dfuller lngdp, lag (1)
dfuller D . lngdp, lag (1)
varsoc lnlit
dfuller lnlit,lag(3)
dfuller D.lnlit, lag(3)
varsoc lnfin
dfuller lnfin, lag(1)
dfuller D.lnfin, lag(1)
varsoc lninfl
dfuller lninfl, lag(1)
dfuller D.lninfl, lag(1)
varsoc lnopen
dfuller lnopen, lag(1)
dfuller D.lnopen, lag(1)
varsoc gdfcf
dfuller lngdfcf, lag(1)
35
dfuller D.lngdfcf, lag(1)
dfuller D.labparticipatingrate, lags (0)
regress lngdp lnlit lnfin lninfl lnopen lngdfcf
predict r, res
varsoc r
dfuller r, lags(2)
regress D.lngdp D.lnlit D.lnfin D.lninfl D.lnopen D.lngdfcf L.r, noconstant
prais D.lngdp D.lnlit D.lnfin D.lninfl D.lnopen D.lngdfcf L.r, noconstant
correlate
vif