RESPONSIVENESS OF MALAWI-SOUTH AFRICA BILATERAL TRADE FLOWS TO CHANGES IN RELATIVE PRICES AND INCOME

Abstract

This study estimated responsiveness of Malawi - South Africa bilateral trade flows to changes in relative prices and income. The analysis was carried out using ARDL bounds testing approach to cointergration. The modeling strategy gave an opportunity for a joint examination of both short run reactions to changes in trade flows as well as the long run determinants of Malawi – South Africa trade flows using annual data from 1980 to 2012.The results revealed a heterogeneous reaction to variables for both export supply and import demand models. Short run joint tests on both models which also incorporated the error correction term revealed no effects from variable changes. On the other hand, Malawi’s export supplies in the long run were effectively altered by domestic prices and bilateral exchange rate. Likewise, the import demands in the long run were successfully altered by domestic income, domestic prices, foreign prices, and bilateral exchange rate. However, the inclusion of the dummy variable to capture the bilateral trade agreement influence in both models was not effective. The findings pointed to the fact that bilateral trade policy should look more on domestic price as a policy instrument. This can be done by focusing on policies that control money supply as money supply is directly linked to Consumer Price Index of Malawi. Furthermore proper bilateral exchange rate alignment was also found to be an effective policy tool for mitigating trade deficits. Additionally, an instigation of long term export-led growth targets such as export industry promotion in support of the Malawi National Export Strategy would fundamentally help Malawi.