UNIVERSITY OF ZIMBABWE

FACULTY OF SOCIAL STUDIES

DEPARTMENT OF ECONOMICS

IMPACT OF FOREIGN DIRECT INVESTMENT ON TRADE BALANCE IN

ZIMBABWE (1980 to 2015)
BY
R143851K
A Dissertation Submitted in Partial Fulfilment of the Requirements of the Bachelor of
Science Honours Degree in Economics
 ABSTRACT

This study main purpose was to analyse the impact of foreign direct investment on trade balance
in Zimbabwe. The analysis was based on time series data for the period 1980 to 2015. Ordinary
Least Squares (OLS) technique have been used for the estimation. The estimated results indicate
that current year foreign direct investment was found to be positive and statistically significant.
This conforms to the hypothesis in Chapter One that there is a positive relationship between
foreign direct investment and trade balance. One year lagged foreign direct investment was
negative but statistically insignificant. One year lagged gross domestic product and trade
openness were found to be statistically significant and negatively affecting trade balance. This
study therefore, recommends policies to be instituted to attract more foreign direct investment
inflows, reduce imports for example importation of essential capital goods only and encourage
exports in Zimbabwe.
 CHAPTER ONE

INTRODUCTION AND BACKGROUND

1.0 Introduction

It is theoretically presumed that Foreign Direct Investment (FDI) plays a positive significant role
in stimulating the current account. In many developing countries, foreign direct investment (FDI)
has to a large extent worked as an alternative to foreign aid as a source of finance to close the
exportimport gap. The relationship between FDI and trade balance can be traced by using
Vernon Product Life Cycle, the Flying-Geese Model and the New Growth Model. These theories
state that FDI will build a countrys export strength through new innovative technology,
development of companies and enhancing international trade. These theories show that there is a
positive relationship between FDI and the trade balance.

In empirical literature, the impact of foreign direct investment on trade balance is still an issue
under debate. Ray (2012) and Shawa, Shen (2013) and Chidoko and Sachikuni, (2015) claimed
that FDI inflows have increased trade balance. However, Falk (2008) and Dinh and Tran (2013)
showed that the impact of FDI inflows have a negative impact on trade balance. Nguku (2013)
found that FDI does not have an impact on imports and exports. In light of improved FDI
inflows, trade balance has been facing a prolonged and unsustainable trade deficit. Therefore,
this study seeks to investigate the impact of FDI inflows on trade balance in Zimbabwe using
time series data from 1980-2015 data. Ordinary Least Squares (OLS) methodology will be used.

1.1 Background to the study

After attainment of independence in 1980, Zimbabwe retained import substitution

industrialization policies inherited from the colonial Rhodesian Government. Zimbabwe adopted
a socialist ideology by instituting structural and re-distributive fiscal policies that sought to
address pre-independence inequalities (RBZ, 2015). Government major objectives where inter
alia, to boost investment. The foreign investment net official flows as a percentage of GDP
became negative. This may be attributed to the foreign exchange which was tightly controlled.
There was not much of a response in trade balance, a slight trade balance surplus and an almost
zero trade balance. The relationship between FDI and trade balance is depicted in Figure 1.
Figure 1: Zimbabwe Trade Balance and Foreign Direct Investment Inflows From 1980-2014

FDI AND TRADE BALANCE

600 1000.0

TRADE BALANCE IN MILLIONS

500 0.0
FDI IN MILLIONS

400 -1000.0

300 -2000.0

200 -3000.0

100 -4000.0

0 -5000.0

2006
1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2008

2010

2012

2014
fdi tradebalance

Source: UNCTAD and RBZ for the period 1980 to 2015

In 1991, Zimbabwe adopted the International Monetary Fund-funded Economic Structural

Adjustment Programme (ESAP) designed to eliminate economic policies of controls and
restrictions (Gwenhamo, 2009. During ESAP period (1991-1996) the country embarked on
exchange rate and trade liberalization. Annual export growth was targeted at 9 percent. The
period coincides with a sharp increase in FDI inflows of US$2.8 million of 1991 to US$117 of
1995 as depicted in Figure 1. Trade balance also improved for this period, this might be
attributed to the exchange rate and trade liberalisation.

The Zimbabwean Government revised the effectiveness of ESAP in 1996. The government
observed that it had failed to accomplish the projected increase in exports and FDI. As a
corrective measure the government implemented the Zimbabwe Political Restoration, Economic
and Social Transformation (ZIMPREST) in 1996. In line with the structural reforms policy the
Zimbabwe Investment Centre (ZIC) was established for investment approvals. To encourage
foreign capital investment, tax and tariff exemptions were offered. Foreign firms geared for
exporting benefited from export processing zone incentives for example customs free trade and
tax holidays. Trade balance was improved during this period as shown in Figure 1. The return to
a liberal economy and enthusiastic promotion of FDI resulted in the surge of FDI inflows
averaging above US$50 million per year between 1990 and 1997 (Gwenhamo, 2009). FDI
inflows reached its peak at a record of US$ 444 million in 1998 as shown in Figure 1.
There was a sharp decrease in FDI inflows from the US $ 444 million of 1998 to US$ 59. This
marked the beginning of the period 1998 to 2008 (also known as the lost decade)), Zimbabwe
experienced political instability coupled with macroeconomic instability. The compulsory land
acquisition enabled by an Act of Parliament rattled investors confidence. There was a fall in the
amount of foreign direct investment inflows coupled with a fall in domestic investment. The
period 1998 to 2008 were also faced with different trade pattern with a consistent decrease in the
balance of trade basing on what figure 1 shows. In the 1990s Zimbabwe trading partners were
developed nations such as Germany, United States of America, European Union and the
Japanese accounting for 60% of international trade. In the aforementioned the country shifted its
trade partners to neighbouring countries such as South Africa, Botswana and Zambia and this
worsened its trade deficits reaching to a level of US$392.2 million (deficit) in 2005.

The period 2008 was characterised by hyperinflation, lack of meaningful production, lack of
confidence in doing business in Zimbabwe by foreign investors and there was lack of foreign
currency for businesses to procure required resources. This led to businesses operating below
their capacity level. In 2009, the country launched Short Term Economic Recovery Programme
(STERP) and also adopted the multicurrency system Kwacha, Rand, Pula and United States
Dollars which replaced the Zimbabwean Dollar. The aim of STERP was to attract more foreign
direct investment and unlocking vital trade finance which is to produce highly diversified exports
which can earn high market value. Thus, the aim of the policy objective was to create conducive
investment environment and improving trade balance through an increase in exports.

Since the introduction of multicurrency and intervention by Government statutory instruments

like SI64, FDI inflows has been increasing since 2009 to 2014 reaching its maximum at
US$544.8 in 2014 and decreased in 2015 as shown in fig 1. However, trade balance worsened
reaching its worst in 2011. The sharp decrease in the trade balance might have been caused by
the economic crisis in which the production of the economy was no longer sustaining domestic
demand. Trade balance improvements can be noted from the year 2012 to 2014 and worsened in
2015 as shown in Figure 1. Having these patterns between FDI and trade balance it is surprising
to note that very few researchers delved into the impact of foreign direct investment inflows on
trade balance in Zimbabwe. It is this gap in literature that this research intends to fill.
1.2 Problem Statement
It is theoretically presumed that FDI positively impact trade balance. FDI helps in improving
domestic production of a country thereby increasing imports and reducing exports at the end
improving trade balance. Since 2002 Zimbabwe has been encountering prolonged and
unsustainable trade balance deficit, which is a consequence of imports surpassing exports. Chief
among the factors that added to this situation is the exportation of primary products prices when
contrasted to processed imports of the country which have high value on the international
market. As a consequence, the export-import gap is widening. FDI is seen as another means of
expanding and broadening export production because it brings new innovations and skills to the
host economy.

Fig 1 shows trends in Zimbabwe trade balance and foreign direct investment inflows
fluctuations. Since the introduction of multicurrency in 2009, FDI inflows have been increasing
reaching its maximum of US$544.8 in 2014. Despite an increase in FDI inflows from 2009 until
2014 trade balance deficits were noticed relative to the decade after independence as shown in
fig 1. It is surprising that as FDI inflows increased trade balance deficits were still noticeable and
later improved. It shows that the impact of FDI on trade balance is unclear. This study, therefore,
seeks to investigate the impact of FDI on trade balance.

1.3 Research Question

What is the impact of foreign direct investment inflows on trade balance?
1.4 Objective of the study

The general objective of the study is to determine the impact of foreign direct investment inflows
on the current account in Zimbabwe. The specific objective is to:

Investigate the impact of foreign direct investment inflows on net exports in Zimbabwe

1.5 Hypothesis

There is a positive relationship between foreign direct investment inflows and net
exports.
1.6 Justification of the study

Foreign Direct Investment (FDI) not only provides Zimbabwe with much needed capital for
domestic investment but also creates employment opportunities improve net exports, all of which
contribute to economic development. Ray (2012) and Shawa and Shen (2013) showed that the
impact FDI inflows trade balance is positive. Falk (2008) and Dinh and Tran (2013) claimed that
FDI flows have contributed substantially to trade balance deficits. Nguku E. K (2013) concluded
that FDI inflows do not have an impact on imports and exports. In Zimbabwe Chidoko and
Sachihuni found a positive relationship between foreign direct investment and balance of
payment. Therefore, the study seeks to investigate the impact of FDI inflows on net exports in
Zimbabwe. The study contributes to the existing body of literature.

1.7 Organization of the rest of the study

Chapter Two will give review of both theoretical and empirical literature while Chapter Three
will give the methodology that will be used in estimating the relationship between variables. In
addition, Chapter Four will present and interpret the results obtained from the estimations done.
Summary and policy recommendations of the study will be presented in Chapter Five.
 CHAPTER TWO
LITERATURE REVIEW
2.0 Introduction

This chapter gives a review to the body of theoretical and empirical literature that has explored
the impact of foreign direct investment (FDI) on trade balance. The research gap is provided in
this chapter. The review of literature will enable formulation of an appropriate model and
adoption of the best methodology.

2.1 Theoretical Literature Review

Foreign direct investment and trade balance theoretical relationship can be explained utilizing the
Vernons product life cycle (PLC), Internalization theory and new growth theory. Despite their
disparities on the explanation of FDI inflows, they all have consensus that FDI positively
influence trade balance of the recipient economy.

2.1.0 Product Life Cycle (PLC) Theory

The PLC theory was developed by Vernon in (1966) and consists of three stages namely, new-
product, maturing-product and standardized-product stage (Appleyard, 2014). PLC best applies
to trade in manufactured rather than to primary products. Since production costs and demand for
production within one country change overtime and vary in different countries, the allocation of
FDI is chosen based on different stage of PLC (Lee, 2007). In the first stage of production (new-
product stage), USA multinational enterprises (MNEs) were producing new and innovative
products. The new commodity is consumed mainly in USA because that is where demand is
located and firms seek to observe the consumer responds. MNEs production seeks local markets
meanwhile the foreign competitors start to come in the market.

If the product is successful new markets are explored and exports are developed. The original
producer (MNEs) through FDI establishes a production unit in the foreign countries to cater to
the increased foreign demand as well as to compete with rivals (Nayak and Choudhury, 2014).
The final stage is characterized by product standardization. The production technique becomes
well-known and achieves its apex. As a result, investment moves on further to any location in the
world where costs are at the lowest possible level mainly to developing countries. Thereafter, the
product is exported to the original country (USA in this case) of innovation where the product is
phased out in order to favour innovation of yet another product. Thus, the importer becomes an
exporter at this stage of production. However, the theory best applies for the trade of the
manufactured products rather than primary products for example minerals and agriculture
produce.

2.1.1 The Flying-Geese (FG) Model

The flying-geese (FG) demonstrates a countrys shifting competitiveness concentrating on the

dynamic adjustments in factors of production countries go in the process of economic
development (Lee, 2007). Kumagai (2008), noted flying geese pattern of development as
initially devised by Akamatsu (1935, 1937, 1962) and then Kojima (1960, 1970, 1995) explained
the concept further. The FG model was grounded on the observation of Asian countries and
intends to explain the catching-up process of developing economies. According to Asian
Development Bank (ADB, 2005), trade openness and labor cost are the important factors of the
flying-geese model. As the low labour cost countries develop they become high cost countries
for a new set of low labour cost host countries. The implications of the FG model are that
Multinational Enterprise (MNE) subsidiaries increase the host countrys export performance by
using host countrys factor endowments to produce at lower cost (Njong and Tchakounte,
2011). In Asia, FDI inflows played a crucial role in the development of new industries and the
substitution of old ones with time lags (Kwan, 1996). Assuming the cost advantage prevails,
flying-geese model suggests increasing exports due to increasing FDI. With new industries,
domestic production is enhanced resulting in decreased imports and an increase in exports. As a
consequence, the recipient countrys trade balance is improved by the accelerated export
competitiveness of the MNEs.

2.1.2 The New Growth Theory

Roomer (1990) is credited with stimulating the New Growth Theory, its central notion was to
explain growth that is economic convergence between and within nations (Aerni, 2012). The
theory incorporates two important points, first view of the New Growth Theory is that
technological progress is a product of economic activity. Second, New Growth Theory states that
unlike physical objects, technology and knowledge exhibits increasing returns. These increasing
returns are the catalyst for economic growth (Cortright, 2001). The crucial point to note in this
theory is that knowledge stimulates growth the theory is often referred to as endogenous grow
due to its internalisation of technology on how markets operates unlike the PLC and the Flying-
Geese models which emphasise on low production cost seeking firms. Resources should be
devoted to research and development for economies to achieve increased rate of innovation and
high growth rates.

The transfer of advanced technology strengthens the host countrys existing stock of knowledge
through labour training, skill acquisition, the introduction of alternative management practices
and organizational arrangements (De Mello and Sinclair 1995). FDI involves the transfer of for
example, higher skills, knowledge and the management from foreign firms to local firms
exporting ability with the host country (Lee, 2007). The implication of this theory is that
domestic production is increased which reduces importation of goods. It is in this idea that trade
balance increases as a result of improved export ability which in turn influenced by FDI.

2.2 Empirical Literature Review.

Hejazi and Safarian (2001), analysed the relationship between trade and FDI stock on a bilateral
basis between United States of America (USA) and 51 other countries. The duo used the gravity
model regressions for trade for 51 countries from 1982 to 1994. The result showed that United
States of Americas FDI and international trade are complements, both inward and outward
stimulates USA trade. The overall impact of FDI on exports exceeds than on imports. In this
sense FDI can be said to increase the trade surplus ceteris paribus. However, USA is one of the
most economically developed nations whilst Zimbabwe is a developing nation, therefore the
results cannot be inferred for Zimbabwe.

Related to the study by Hejazi and Safarian (2001), effects of FDI inflows on exports in 12
Central and Eastern European economies was carried out by Kutan and Vuksic (2007). The
Generalized Least Square method on pooled data over the period 1996 to 2004 was used in this
study. The couple found that FDI inflows enhance production capacity of the host country in turn
increasing export supply potential. The FDI-specific impacts arise because the MNEs may have
superior knowledge and technology, information about the markets for exports than the domestic
firms have. The study employed a whole lot of variables in modelling though trade openness
which is regarded to have significant impact on export growth was not used. The findings show
that FDI has increased domestic supply capacity and exports for all countries in their sample.
The study focused on FDI impacts on exports, there is need to find FDI impacts on trade balance.
There is a consensus between the studies by Hejazi and Safarian (2001) and Kutan and Vuksic
(2007). In this regard, it can be noted that FDI positively impact trade balance for developed
nations.

Using panel data, Hailu (2010) examined the impact of FDI on Trade Balance of African
countries (excluding Zimbabwe and other African countries) for the period 1980 to 2007. Due to
data heterogeneity, non-continuity and because the Hausman test favours it over the random
effect technique, the Least Dummy Variable (LSDV) regression method was used. The results
obtained reflected that expanding FDI in the region will have a positive effect for export
promotion and subsequently to trade balance. Zimbabwe is one of the African countries in which
the impact of FDI on Trade Balance hypothesis found support but the study only picked sixteen
African countries leaving Zimbabwe. The study was not specifically done for Zimbabwe alone
to see whether the hypothesis will hold or not.

In addition, another cross-country study was carried out by Dinh and Tran (2013). The duo
investigated the relationship between FDI inflows and trade balances for developing Asian
countries using general least squares method for the period 1991 to 2011. FDI was found to be
statistically significant and positive implying that the current FDI inflows increase
simultaneously exports, imports and resulting trade balance. The study further on observed that
FDI can boost worsen trade balance even though it simultaneously contributes to an expansion of
export earnings. The study ignored other important variables like lagged FDI and trade openness
which are generally regarded to have a significant impact on trade balance. The results obtained
for the two continents Asia and Africa are different.

Shawa and Shen (2001), analyses the determinants of trade balance in Tanzania using the
ordinary least squares (OLS) method. The study used time series data from the year 1980 to
2012. They used foreign direct investment, human capital development, household consumption
expenditure, government expenditure, inflation, natural resources availability, real exchange rate
and foreign income and trade liberization to determine which variables significantly determine
balance of trade. The empirical results showed that all variables were significant except for real
exchange rate, FDI had a significant positive coefficient of elasticity. However, Tanzania is one
of the developing nations in the Southern African Developing Community (SADC) but the fact
that it is not a landlocked country, the results cannot be a true reflection on Zimbabwean
situation. The study used current FDI leaving the lagged FDI which might have impact to the
countrys trade balance.

An analysis of the determinants of Balance of Trade in India over the period of 1972 to 2011 was
carried out by Ray (2012). Several econometric techniques and tools like Dickey Fuller test,
Johansen cointegration test, Vector Error Correction Model (VECM) and OLS have been used.
The result suggests that long-run and short-run causality existed among different macro-
economic variables like real effective exchange rate, FDI, domestic consumption and foreign
income. The empirical results showed that FDI has a positive impact on balance of trade. Non-
stationarity in all variables and long-run association among the variables were observed. The
error correction estimates gave evidence that there exists short-run causality among variables.
India is one of the Asian developing countries but the results obtained by Ray (2012) are not
consistent with those obtained by Dinh and Tran (2013). This might be due to differences in the
time periods covered by the two scholars.

Using the Ordinary Least Squares(OLS) method, Tran (2012) had a quest to find factors
affecting trade balance of Vietnam using monthly data from 2002 to 2011. Variables such as
domestic price, oil price, FDI, government spending, manufacturing growth rate were used. The
researcher observed that domestic price had a negative impact on trade and all other factors
including FDI had no impact on trade balance. The study used monthly data whilst this paper
will use yearly data. Tran (2012) did not use any of the trade intensity indicators such as the
trade openness, to examine the impact of economic integration on export and import growth.

Consistent with the results by Tran (2012), were the results by Nguku (2013) who carried out a
study on the relationship between FDI and Balance of Payment in Kenya. The author used time
series data for the period 1993 to 2012. Descriptive analysis as well as OLS regression analysis
were used. The study observed that FDI does not impact on export and imports. Since trade
balance is comprised of imports and exports, this means Nguku (2013) observed that FDI does
not impact trade balance. Nguku (2013) results are not consistent with those obtained by Hailu
(2010) who found a positive relationship between FDI and trade balance in Africa. This might be
attributed to time differences the studies were carried out.

Impact of trade Openness, foreign direct investment, exchange rate and inflation on economic
growth in Pakistan was carried out by Bibi and Rashid (2014). The analysis was based on time
series data for the period 1980 to 2011. Co-integration and Dynamic Ordinary Least Square
(DOLS) techniques were used for the estimation. The study results showed that foreign direct
investment have positive but not significant impact on economic development. However, the
study is based on a broad variable that is economic growth, this study will focus on trade balance
a component of economic growth.

In Zimbabwe, Sakuhuni and Chidoko (2015) analyses the impact of foreign direct investment
(FDI) on the Balance of Payment in Zimbabwe. The couple employed the ordinary least squares
method (OLS) using time series data for the period 1981 to 2013. In this recent empirical study,
a positive correlation between FDI and Balance of Payment was observed. However, Sakuhuni
and Chidoko (2015) focused on the broad component of the Balance of Payment which is the
Current Account, this study will concentrate on the narrower component of the Balance of
Payment.

2.3 Conclusion

This present section is a foundation of how FDI impacts trade balance. Majority of the empirical
studies have shown that FDI impacts trade balance positively using time series data. Some of the
studies have shown that there is insignificant evidence to claim FDI affects trade balance
performance of the host nation. Theoretically, FDI positively affects trade balance as supported
by Flying-Geese Model, Product Life Cycle Theory and The New Growth Theory. Several
studies are cross-country studies which assume common economic structure and similar
production technology which may in fact not be true (Hejazi and Safarian, 2001). Inconsistency
in results is based on different methodologies, approaches and proxies used in the study. With
this in mind, this study tries to investigate the impact of FDI on trade balance of Zimbabwe using
Ordinary Least Squares method. The following chapter will be looking at the methodology used
in the study closely following Ray Nguku (2013).
 CHAPTER THREE
METHODOLOGY
3.0 Introduction
This section presents the modelling and estimation of the effect of foreign direct investment on
trade balance in Zimbabwe using the annual time series data for the period 1980 to 2015. It
includes the empirical model specification, variable justification, statistical diagnostic tests, data
sources and specifies the type of data used in regressing the model. The study closely followed
Nguku (2013).

3.1 Empirical Model Specification

The methodology was conducted following Nguku (2013) and the Ordinary Least Squares
estimation used to answer the research question. Necessary adjustments were made through
dropping and addition of some variables based on theoretical and empirical justifications for the
model to suit the Zimbabwean situations. The model was specified as follows:

TBt = 0 + 1FDIt + 2FDIt-1 + 3TOt + 4GDPt-1+ 5TARt + t

Where:
TBt is the trade balance; FDIt is the foreign direct investment; FDIt-1 is the lagged foreign direct
investment; TOt is the trade openness; GDPt-1 is the lagged gross domestic production; TARt is
the tariff; t is a white noise error term; s the parameters to be estimated.

3.2 Definition and Justification of Variables

Trade Balance (TBt)

The trade balance is the difference between a countrys imports and its exports for a certain
period. Trade balance represents a significant share in GDP. An increase in the trade balance
increases a countrys GDP therefore increasing economic growth. Trade balance can be proxied
as the difference between exports and imports as a percentage of gross domestic product. In this
study trade balance was used as the difference between exports and imports as used by Ray
(2012).
Foreign Direct Investment (FDIt)

Foreign direct investment is a category of cross-border investment associated with a resident in

one economy having control or a significant degree of influence on the management of an
enterprise that is resident in another economy (World Bank, 2016). Current FDI was included to
see if it effects domestic industries production capacity, reducing imports and increasing the
export performance of a country instantaneously. Hailu (2010) in his study and found a positive
relationship between FDI and trade balance. The data of FDI inflows is in millions of American
dollars and the coefficient is expected to be positive.

Lagged Foreign Direct Investment (FDIt-1)

The lagged FDI entered the model following suggestion by Hailu (2010). Hailu (2010) noted that
the lag structure of the model is to capture the relatively longer time period, which may be
required for the impacts of FDI to be felt on export performance. The overriding hypothesis is
that effects of FDI on export performance is not instantaneously due to dissemination of new
production technologies, modernizations of production facilities and other changes require time
to take effect. The data of lagged FDI inflows is in millions of American dollars and the
coefficient is expected to be positive.

TRADE OPENNESS (TOt)

Bredenkamp and Schadler (1999) defined trade openness as the deliberate relaxation of local and
international regulations on trade that is freeing the market so as to allow free trade and
enterprise in the economy by all economic agents. Openness index is measured as the total
international trade (Exports plus Imports) ratio on total value of net output (gross domestic
product) (Squalli and Wilson, 2006). This variable is regarded as an essential factor in Flying
Geese Model of FDI trade balance relationship and is expected to have a positive sign.

LAGGED GROSS DOMESTIC PRODUCT (GDPt-1)

McConnell et al (2009) defines GDP as the total market value of final goods and services
produced within a country during a specific time period, usually a year. One year lagged GDP is
adopted as a proxy variable for supply capacity. This variable enters the model following
suggestion by Kutan and Vuksic (2007). The variable is measured in United States dollar values
and the priori expectation sign of lagged GDP is positive.
TARIFF (TARt)

A tariff is an obligatory duty or tax levied on exports or imports by authorities in an economy as

a way of controlling or restricting trade and also to raise revenue (Lipsy, 1975). Tariffs
determine the cost of transactions across borders. Increase in tariffs reduces the quantity of
imports, this increases trade balance of the country. In the study, the average tariff rate was used.
A positive coefficient of tariff is expected.

3.3 Model Estimation Procedure

Ordinary Least Square technique was applied in this study, which is effective in its estimation
procedure of the Classical Linear Regression Model (CLRM) as it produces Best Linear
Unbiased Estimators (BLUE) estimates (Gujarati, 2004). This means the estimators are linear,
unbiased, efficient and consistency.

3.4 Stationarity test

When regressing time series variable on another time series variable there are chances of getting
high R-Squared although there may be no relationship between the variables. The unit root test
was examined to test whether the time series variables are stationary or non-stationary. The
stationarity of data is when the series has constant mean, variance and auto covariance. When the
time series variable is non-stationary, Classical Linear Regression estimators are likely to be
inflated and also inconsistent with a low Durbin Watson statistic. Augmented Dickey-Fuller
(ADF) test was used to estimate the unit root where the null hypothesis is rejected when the
calculated statistic is more negative than the critical value.

3.5 Model Diagnostic tests

Diagnostic tests were carried out starting with multicollinearity. Multicollinearity means
existence of a perfect or exact, linear relationship among some or all explanatory variables of a
regression model (Gujarati, 2004). If it does exist it causes large R-squared, inflation of
variances, large confidence interval thereby accepting the null hypothesis and precise estimation
will be difficult to find. This study therefore used the pairwise method to examine the existence
of multicollinearity. If the correlation coefficient is in excess of 0.8 it shows a strong existence of
collinearity (Gujarati, 2004).
Heteroscedasticity test is also one of the crucial tests that was conducted before results were
interpreted. Heteroskedasticity is a situation where the error variance is no longer constant as it
depends on the explanatory variables. Heteroskedasticity does not violet the unbiasedness and
consistency properties but variance will no longer be minimum as a result affecting the
confidence interval and hypotheses testing. This will give incorrect confidence interval, F tests
and other crucial econometric tests. Breusch-Pagan test was used to detect the presence of
heteroscedasticity.

The autocorrelation test seeks to examine if errors from the previous period are not being carried
to the next period. With the same consequences as heteroscedasticity, Breusch-Godfrey test was
used to detect autocorrelation.

In addition, normality test was conducted before interpretation of results. Normality enables the
derivation of probabilities and also the F test and t test are based on normality assumption. To
test for normality Jacque-Bera (JB) test was used. If p-value is greater than the level of
significant, the error terms are normally distributed.

Finally, Ramsey Regression Specification Error Test (RESET) was used to test model
specification bias. If the model was not correctly specified the researcher would have encounter
the problem of model specification bias (Gujarati, 2004). P-value and F-test was used to test the
significance of each variable and the significance of the whole model respectively. Other
variables like R-squared will also be considered and commented.

3.6 Data Sources, Type and Period

The study collected secondary data. Data for trade balance and tariff was obtained from Reserve
Bank of Zimbabwe (RBZ). The data for trade openness and GDP were sourced from World
Bank. FDI inflows data comes from UNCTAD. The time series data was collected for a 35-year
period from 1980 to2015. Annual data was used in this study.

3.7 Conclusion
This chapter of the study gave an overview of methodology and data sources which were
employed in regression analysis. Chapter 4 focuses on the estimation, presentation and
interpretation of this research results.
 CHAPTER FOUR

ESTIMATION, PRESENTATION AND INTERPRETATION OF RESULTS

4.0 Introduction

This chapter presents empirical results from the estimations done, as presented in Chapter Three.
Descriptive statistics were presented first, stationarity tests, multicollinearity and regression
results are presented respectively. This chapter also gives interpretation of results obtained from
regression analysis. E-views 7 software was used for the tests.

4.1 Descriptive statistics

Table 1: summary of descriptive statistics.

TB FDI FDI_1 TO GDP_1 TAR

Mean -377.9297 104.2319 92.24756 0.708571 7628.379 0.325760
Median -58.70000 51.60000 40.00000 0.700000 6858.013 0.329000
Maximum 401.2516 544.8000 544.8000 1.710000 14196.91 0.510200
Minimum -3298.152 0.841285 0.841285 0.380000 4415.702 0.147000
Std Dev 879.3469 143.3645 133.2832 0.296867 2154.920 0.115467
Skewness -1.626829 1.816222 2.120507 1.415818 1.359825 -0.100670
Kurtosis 5.083049 5.055905 6.536530 5.276195 4.636043 1.705157
Jarque-Bera 21.76619 25.40619 44.46930 19.24886 14.68998 2.504188
Probability 0.000019 0.000003 0.000000 0.000066 0.000646 0.285906
Observation 35 35 35 35 35 35

According to Table 1, trade balance and tariff are negatively skewed. Foreign direct investment,
lagged foreign direct investment, lagged gross domestic product and trade openness are
positively skewed as shown in Table 1. The variables trade balance, foreign direct investment,
lagged foreign direct investment and lagged gross domestic product have relatively large
variations whilst variations for trade openness and tariff are relatively small as shown by
standard deviations of these variables. Only tariff is normally distributed as indicated by the
Jarque-Bera probability value which is greater than 10 percent. However, normality of variables
is not important in regression estimation, it is only there for convenience purposes.
4.2 Stationarity test results

The study tested stationarity of variables. This test was conducted using Augmented Dickey-
Fuller (ADF) test in Eviews 7 software. The results are shown in Table 2.

Table 2: ADF Unit Root test results in levels

Variables Dickey Fuller Critical value Critical value Critical value Order of
tests at 1% at 5% at 10% integration
TB 2.399825 -3.639407 -2.951125 -2.614300 Non stationary
FDI -0.265029 -3.632900 -2.948404 -2.612874 Non stationary
FDI_1 1.496594 -3.639407 -2.951125 -2.614300 Non stationary
GDP_1 0.113155 -3.639407 -2.951125 -2.614300 Non stationary
TO -1.817767 -3.639407 -2.951125 -2.614300 Non stationary
TAR -3.479834*** -3.632900 -2.948404 -2.612874 I(0)
** entails stationary at 5% level of significance and I() shows order of integration

Trade balance, foreign direct investment, lagged foreign direct investment, lagged gross
domestic product and trade openness were not non-stationary and were to be differenced in Table
3. Of all the variables only tariff was found to be stationary at 5 percent significance level.

Table 3: ADF Unit Root test results in First Difference

Variables Dickey Fuller Critical value Critical value Critical value Order of
tests at 1% at 5% at 10% integration
DTB -9.296715* -3.639407 -2.951125 -2.614300 I(1)
DFDI -5.755941* -3.639407 -2.951125 -2.614300 I(1)
DFDI_1 -4.630858* -3.646342 -2.954021 -2.615817 I(1)
DGDP_1 -4.374363* -3.646342 -2.954021 -2.615817 I(1)
DTO -6.547737* -3.646342 -2.954021 -2.615817 I(1)
D means first difference whilst * means stationary at 1% level of significance.
After first difference, variables trade balance (TB), foreign direct investment (FDI), one year
lagged foreign direct investment (FDI_1), trade openness (TO) and one year lagged gross
domestic product (GDP_1) became stationary at 1% level of significance. Thus, they are
integrated of order one.
4.3 Multicollinearity test results

Table 4: Correlation matrix results

DFDI DFDI_1 DGDP_1 DTO TAR
DFDI 1
DFDI_1 -0.095267 1
DGDP_1 0.191080 0.443284 1
DTO -0.072041 -0.073278 0.003865 1
TAR 0.040010 -0.248849 -0.024169 0.070557 1

From table 4, all the pair-wise correlations are less than absolute 0.8, meaning that there is no
serious problem of multicollinearity. Hence, Plainly, explanatory variables do not move together
in systematic ways meaning that there is no exact linear relationship among the independent
variables, thus their individual effects on the explained variable can be isolated (Gujarati, 2004).

4.4 Estimated OLS Regression results

Ordinary Least Squares (OLS) using E-views 7 statistical package gave the results in Table 5
below.

Table 5: Estimated OLS Regression results

Dependent variable: d(TB)

Variables Coefficient Std. Error t-statistic p-value
C -326.4138 175.8501 -1.856205 0.0740
DFDI 2.190561 0.960006 2.281820 0.0303**
DFDI_1 -0.729182 1.186239 -0.614700 0.5437
DGDP_1 -0.206557 0.057846 -3.570818 0.0013*
DTO -776.4324 197.6964 -3.927398 0.0005*
TAR 806.1412 505.5279 1.594652 0.1220
*and ** means the variables are significant at 1% and 5% significant level respectively.

R-squared 0.603125 Adjusted R-squared 0.532254 F-statistic 8.510229

Prob (F-statistic) 0.000054 Durbin-Watson stat 1.857122
The coefficient of determination (R-squared) and its quality checker (adjusted R-squared) are
0.603125 and 0.532254 respectively as shown in Table 5. This shows that 60.31% of the
variations in the trade balance are explained by variations in the significant independent
variables. The R-squared is close to the adjusted R-squared, which shows that the R-squared is
reliable. The whole model is significant at 1% level of significance as shown by the probability
of F-statistic 0.000054, which is less than 0.01 with an F statistic of 8.510229. Durbin-Watson
statistic is 1.857122 which is close to two proving the absence autocorrelation

4.5 Diagnostic test results

Econometric problems of serial correlation, heteroscedasticity, functional form and normality of
the errors are examined through the standard diagnostic tests (Table 6), in each case the null
hypothesis could not be rejected at conventional 5% level of significance, implying thereby that
our results are statistically free from any specification problems

Table 6: Results of the model diagnostic test

P-value Decision at 5%
Autocorrelation 0.1911 No autocorrelation
Heteroskedasticity 0.1556 No heteroscedasticity
Model specification 0.6322 Model correctly specified
Normality 0.961919 Errors are normally distributed

Using Breusch-Godfrey Serial LM test, results in Table 6 show no serious problem of

autocorrelation in errors exists since the probability value of 0.1911 is greater than 0.05.
Breusch-Pagan test for heteroscedastic shows that there is no heteroscedasticity of the error
variance in the model since the probability value of 0.1556 is greater than 0.05. Ramsey
Regression Specification Error Test (RESET) shows the model is correctly specified since the F
probability value of 0.6322 is greater than 0.05. The Jarque-Bera (JB) probability value is
0.961919 which is greater than 0.05 implying that errors are normally distributed. Since the
model has passed the diagnostic test, interpretation of results follows.

4.6 Interpretation of results

The current period foreign direct investment coefficient was found to be positive and statistically
significant at 5% level. This is consistent with the hypothesis in Chapter One that FDI positively
impacts trade balance. A unit increase in current period FDI inflows will result in 2.2 increase in
trade balance. The results support the FDI-trade hypotheses explained in Vernons (1966)
Product Life Cycle, New Growth Theory and Flying Geese Model. These theories explained the
positive impact of FDI on trade balance regardless of their differences in the ways in which FDI
affects trade balance of the host economy. Furthermore, the results were found to conform to the
prior expectations. This study found that in Zimbabwe FDI inflows play an important role in
increasing trade balance performance. These results are consistent to those obtained by Shawa
and Shen (2001), Hailu (2010) and Ray (2012).

According to the results in Table 5, one year lagged foreign direct investment have negative
impact but insignificant. However, the results are contrary to the prior expectation and Nguku
(2013) also found the same result.

The relationship between trade openness and trade balance was empirically found to be negative.
The trade openness coefficient was found to be statistically significant at 1% level of significant.
However, the results are contrary to the anticipated sign. The results are similar to those obtained
by Bibi and Rashid (2014).

Contrary to the expected sign in Chapter Three, one year lagged gross domestic product to be
negative and statistically significant at 1% level. This implies that a unit increase in one year
lagged gross domestic product result in approximately 0.206557 decrease in current trade
balance.

4.7 Conclusion
The empirical results obtained from E-views 7 package after the model had passed diagnostic
tests using Ordinary Least Square methodology. Current foreign direct investment, trade
openness and one year lagged gross domestic product were found to be statistically significant
whilst one year lagged foreign direct investment and tariff were statistically insignificant in
explaining trade balance of Zimbabwe. Furthermore, the results found in this chapter will create
the basis for policy recommendation and suggestion to areas of further study in Chapter Five.
 CHAPTER FIVE

SUMMARY, CONCLUSION AND POLICY RECOMMEDATIONS

5.0 Introduction
This chapter provides the conclusion and policy recommendations based on the empirical results
from Chapter Four. Suggestions for areas of further study are also given.

5.1 Summary of the findings and conclusion

The main concern of the study was to determine impacts of foreign direct investment on trade
balance of Zimbabwe. Time series data was used for the period 1980 to 2015 using the ordinary
least square (OLS) methodology applied in E-views 7 software package.

Based on the empirical findings, current foreign direct investment, trade openness and one year
lagged gross domestic product were found to be statistically significant whilst one year lagged
foreign direct investment and tariff were statistically insignificant in explaining trade balance of
Zimbabwe. Therefore, the study failed to reject the hypothesis that foreign direct investment
positively affects trade balance.

5.2 Policy Recommendations

Basing on the estimated empirical results, it is proper to recommend areas that need attention of
policy makers in Zimbabwe.

With regard to foreign direct investment, research findings indicate the need for more foreign
direct investment to boost trade balance. Ordinary Least Square results show that, current foreign
direct investment is positively related to trade balance hence Government attention should be
paid to the creation of policies that are favourable to foreign investors meant to close the export-
import gap. Government should liberalise the ease of doing business for foreign investors. By so
doing, it is more likely that Zimbabwe industrial sector will expand in their production such that
their products would be reasonable in the global market. This will result in increased exports
relative to imports and finally an increase in the trade balance.
The main reason why there is trade deficit is because imports are surpassing exports. Export
promotion policy should be analysed and import substitution policy should also be examined, so
that country can take benefit from trade. The Government should boost exports and encourage
domestic products. Only the essential capital goods should be imported which help in the
production of goods.

5.3 Limitations of the Study and Suggested Areas for Further Research

This is not the end of research. This research can be used as a base for further research works.
The study used ordinary least squares method to investigate the effect of foreign direct
investment on trade balance in Zimbabwe over the period 1980 to 2015. Cointegration of the
series was not tested which is crucial to establish the relationship between them, that is whether
long run or short run relationship exists. Therefore, cointegration can be used and if the long run
relationship exists, there is room to apply the error correction model in the study. Bidirectional or
no relationship might exist between trade balance and FDI. Hence, others can use Granger
causality to investigate the causality between trade balance and FDI.

In this study, the researcher focused on trade balance as a whole. However, there is need to
undertake researches in different sectors like manufacturing and mining industries of the
economy using panel data, to check the complementary relationship exists.