The impact of trade incentives on exports, balance of payments and economic growth in Kenya:an empirical analysis

Abstract

The object of this paper was to develop, estimate and simulate the effects of trade incentives on exports, balance of payments and economic growth in Kenya. The study was motivated by a lack of systematic analysis of the relationship between Kenya's trade policy incentives and its macroeconomic performance. The study is important both in terms of validation of theoretical models often used in such studies and for guiding the choice of a policy mix consistent with the structural and economic institutions in Kenya. A five equation general growth model in which real exports enter as an input in the production process was developed. Real exports were introduced as a variable to be able to incorporate the possible advantages of policies designed to promote exports. The equations were estimated using both two stage least squares (TSLS) and ordinary least squares (OLS) techniques with time series data for the period, 1966-86, and validated by dynamic expost and policy simulations. The signs and statistical significance of the estimated coefficients, as well as the dynamic validity of the simulations strongly supports the model empirically. The study clearly and strongly confirms the conclusion that trade is very important in Kenya's development process but is shown to be more in the nature of a "handmaiden" rather than an "engine" of growth. More important than the statistical significance of individual parameters, was a rigorous test of the validity of the model provided by the dynamic ex-post and policy simulations over the sample period. The policy simulation exercises performed showed that trade policies were sub-optimal and that they were consistent to Kenya's macroeconomic structure. If improved, they could raise export earnings, investment and economic growth.