Testing for the Marshall–Lerner condition in Egypt: an empirical analysis

Abstract

PurposeThe purpose of this paper is to examine to what extent evidence can be found for the presence of the Marshall–Lerner (ML) condition regarding the trade balances of Egypt. The theoretical basis of the ML is presented and then tested using Egyptian trade data from 1965 to 2017.Design/methodology/approachThe data are analysed via standard ordinary least squares models subject to the constraints imposed by economic theory, specifically ML theory, in which the coefficients represent elasticities. A range of tests are undertaken to establish the validity of the models and the model results including multicollinearity, unit root and co-integration in order to avoid spurious regressions.FindingsThe export model strongly suggests that real exports of Egyptian goods and services are elastic with respect to changes in the real effective exchange rate (REER), with a coefficient weight of −1.64 and is significant at 1%. However, for the import model the coefficient weight of the REER −1.17 and is significant at 1%. This result contradicts ML theory, where an increase in the REER makes imports cheaper and thus causes them to increase.Research limitations/implicationsThe limitations of the study are two in particular, the first is that the frequency of the data employed is annual, not monthly or even quarterly, which means that the sample size would have been larger, and the estimated parameters could have been more accurate in forecasting the future behaviour of exports and imports. There could be several other indicators that might have clear impacts on exports and imports. In other words, it is possible that a model with consumer spending and government spending as well as terms of trade, inflation, interest rate spread and taxes is going to capture more of the variation that occurs in Egypt's trade balance components.Practical implicationsThe results suggest that the Egypt-International Monetary Fund plan (depreciation) is likely to have a positive effect on the economy. However, this does not mean that the deficit of the trade balance is going to change into a surplus once the policies of the plan are fully applied, but it does mean the deficit will reduce. Only in the long run is the trade balance likely to record a sustainable surplus. But the latter will heavily depend on the structure of exports and imports and maintaining price stability, both of which are key government policy areas.Originality/valueThe paper builds on previous theoretical and empirical work in this field and in particular is focussed on Egypt. There are extremely few analyses of the ML condition regarding Egypt. This paper provides new information on this and can also be utilized by researchers to further develop the analysis and method through identification of other potentially relevant variables within a single country ML study.