The Causal Relationship between Trade Openness and Economic Growth in Tanzania

Abstract

This paper analyses the relationship between trade openness and economic growth in Tanzania; and uncovers the direction of causality between trade openness and economic growth. The analysis uses the Vector Autoregressive Model, which is a time series model suitable in capturing dynamic interrelationship among variables. Data involved yearly time series data covering the period of 1970 to 2021 using the causality test. The analysis was informed by the Heckscher-Ohlin theory, which suggests that by capitalizing on abundant factors of production and produce goods which have comparative advantage, trade can lead to economic growth. It was found that trade openness, lagged to one period, positively and significantly affects economic growth in Tanzania. The growth rate of GDP lagged to two periods depicts a significant positive influence on GDP growth rate. Also, the gross national savings, measured as a percentage of GDP lagged to two periods, is statistically significant and negatively related to the GDP growth rates. In addition, the findings showed a negative and statistically significant relationship between inflation lagged to two periods and the GDP growth rate. The causality test rejected the null hypothesis of no evidence of Granger causality between trade openness and economic growth. However, the test could not account for the magnitude of causality. It is recommended that the country foster trade liberalization by pursuing policies that promote trade such as reducing tariffs, streamlining custom procedures, and eliminating non-tariff barriers to trade. It is also important to encourage Foreign Direct Investment, to invest in infrastructure development, to ensure optimal savings, and control inflation to promote economic growth.