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A dynamic relationship between savings and investment: The tales of China and the ASEAN-5

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Available Online: http://saspjournals.com/sjebm 568

Scholars Journal of Economics, Business and Management e-ISSN 2348-5302

Chang Lee Shu-Jung et al.; Sch J Econ Bus Manag, 2014; 1(11):568-575

p-ISSN 2348-8875

© SAS Publishers (Scholars Academic and Scientific Publishers)

(An International Publisher for Academic and Scientific Resources)

A dynamic relationship between savings and investment: The tales of China and

the ASEAN-5

Mei-Se, Chien1, Chang Lee Shu-Jung2*, Chien-Chiang Lee3, Hui-Ting Hu4

1

Professor, Department of Finance and Institute of Finance and Information, National Kaohsiung University of Applied Sciences, Taiwan

2

Professor, Department of Leisure and Recreation Management, National Taichung University of Science and Technology, 129, Sec. 3, San-min Rd., Taichung, Taiwan

3

Department of Finance, National Sun Yat-Sen University, Kaohsiung, Taiwan

4

Department of Finance, National Kaohsiung University of Applied Sciences, Kaohsiung, Taiwan *Corresponding Author

Chang Lee Shu-Jung

Email:

Abstract: This paper applies recursive cointegration analysis to examine the dynamic changes in Feldstein-Horioka

(1980) savings-investment (S-I) coefficients across China and the ASEAN-5 countries over time. To the extent that the S-I coefficients measure international capital mobility, the main empirical results are as follows. First, the recursive trace statistics show that savings-investment linkages vary in these six countries. Second, there is no cointegration between the two factors in four countries - China, Singapore, Malaysia, and Thailand - meaning that capital market mobility in these countries is high and domestic investment in the four is financed by the global pool of capital. Third, for Indonesia and Philippines, there is a cointegration between savings and investment before 2001 for them, implying that they achieved highly mobile and open capital markets later than the other countries.

Keywords: Savings, Investment, Recursive cointegration test, ASEAN, China INTRODUCTION

East Asia has become more integrated through strong growth in cross-border trading and economic activities over the past two decades, which also have resulted in greater cross-border financial activities. Some important works that refer to trade and finance for regional institution building have targeted this region. In the financial arena, governments have encouraged cross-border financial transactions through financial market deregulation and capital account liberalization. Thus, the emerging stock markets of China and ASEAN countries have played a more important role for international fund managers to manage portfolio diversification. Under this background, this paper examines mobile capital movement among China and the ASEAN-5 countries, and most notably whether the degree of capital mobility has increased due to the region’s deepening development of economic integration.

There are many dynamic emerging economies in East Asia, with most of them regulating capital flows across countries during the period from the 1960s to 1970s. In the 1980s, these economies deregulated exchange rate controls and carefully and gradually initiated measures for capital account liberalization. In

the 1990s, they speeded up the liberalization of their capital markets so as to increase international capital mobility. These capital account deregulation policies caused substantial capital inflows into the region in the 1990s, eventually being one of sparks for the 1997 Asian financial crisis.

Some academic papers have also investigated international market linkages with East Asia markets. A frequently reported stylized fact in modern open economies is the degree of mobile capital between countries with some methods proposed to analyze this topic. One strand of the related literature is advocated by Feldstein and Horioka [1](hereafter, FH), who estimate how closely related savings and investment are across countries. The literature on the FH puzzle has quickly grown, with extensive empirical studies of the issue differing significantly in terms of the methodology applied, the dataset, and sample periods covered.

Numerous studies use cross-section regressions to examine the FH puzzle by comparing the results of different countries, such as Artis and Bayoumi [2], Dooley, Frankel, and Mathieson[3], Feldstein[4], Feldstein and Bachetta[5], Murphy[6], Obstfeld[7],

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Penati and Dooley[8], Tesar [9], etc. Another line of the literature applies time-series analysis to provide a wider dispersion of savings-investment (SI) coefficients, including Alexakis and Apergis [10], Apergis & Tsoulfidis[11], Bajo-Rubio[12], Caporale, Panopoulou, and Pittis [13], De Vita and Abbott [14], Obstfeld[15], Pelagidis and Mastroyianni [16], Sinha & Sinha[17-18], etc. By considering the use of full information of the data and in order to improve several of the shortcomings of individual time series methods, an increasing number of recent studies has chosen the panel data methodology for analysis, such as Coakley and Kulasi [19], Coakley, Kulasi and Smith[20], Corbin [21], Ho[22], Jansen [23], Kim [24], Kollias, Mylonidis and Paleologou [25], etc.

Most empirical studies focus on examining the FH puzzle in OECD countries and developed countries, with few papers the issue in developing countries. Hence, this paper looks at the FH puzzle in China and the ASEAN-5 countries to fill the gap in the literature. The above-mentioned literature treats the relationship between savings and investment as a static concept, but this assumption may not be warranted, because structural breaks are a common problem in a macroeconomic series. Instead, linkages between savings and investment may be time-varying and episodic. In the long run, a macroeconomic series that includes savings and investment may contain a variety of structural changes, or be described as undergoing a gradual and ongoing process, which is not a static concept, within a country or at the international level. Hence, considering the importance of time variation in the savings and investment nexus, this paper employs recursive cointegration to study the dynamic evolution of the long-run relationship between the two, which is the Feldstein-Horioka model. Recursive cointegration tests[26] can analyze the degree of convergence during different sub-sample periods of the full sample by using the cointegration rank tests of Johansen[27-28]. The results shall explain the implications of the time-varying behavior of these linkages in China and the ASEAN-5.

LITERATURE REVIEW

For the last several decades the Feldstein-Horioka puzzle has been discussed and examined by many studies. The literature includes some excellent surveys of the related works, such as Obstfeld and Rogoff[29] and Apergis and Tsoumas[30]. Many theoretical papers have targeted to resolve the puzzle, including setting up a model of non-traded goods[31], an IS-LM model considering the optimal policy[32], a model with long-run current account solvency[20, 32], a model with trade costs and barriers[29], non-linearity between the current account and real interest rate[34-35] and more financial frictions[36].

Some papers discuss the FH puzzle by applying different methodology and econometric techniques. In general, this puzzle has been mainly replicated using cross-section regressions (see, among others [2-9], Time-series analysis has provided a wider dispersion of the FH puzzle [10-19]. For example, Jansen (1997, 2000) indicates that the high correlation between savings and investment is caused by their cointegration over time rather than from capital immobility. Along this line of empirical analysis, more various econometric techniques have been used to examine the puzzle, including ARIMA[37], cointegration [38], ARDL bounds test[14, 25], cointegration with structural breaks [39], non-linear time series[34-35], panel cointegration [22, 24, 40], and the panel smooth transition approach[42]. Although the literature has applied various new and sophisticated econometric techniques, the examining results of the FH puzzle remain inconsistent.

Most related empirical studies in the literature focus on the FH puzzle in the OECD countries and developed countries, with papers rarely looking at developing countries: Kim et al. [42] for Asian countries and Ozmen [43] for Middle East and North African countries, to name just a few. Hence, this paper examines the FH puzzle in China and the ASEAN-5 countries to fill the gap in the literature. By considering the importance of time variation in the savings and investment nexus, we utilize recursive cointegration[26] to analyze the dynamic evolution of their long-run relationship in China and the ASEAN-5 countries.

METHODOLOGY

The approach of Feldstein and Horioka [1]

The FH approach entails an estimation of the following regression:

𝐼

𝑌 𝑡 = 𝛼 + 𝛽 𝑆

𝑌 𝑡 + 𝑈 (1) Here, I is gross domestic investment, S is gross domestic savings, and Y is gross domestic product. Coefficient β, which is the so-called savings retention coefficient, measures the degree of capital mobility. As Feldstein and Horioka [1] indicate, Equation (1) allows one to investigate the capital mobility hypothesis. If capital is perfectly mobile, then investors focus only on the rate of return on their investments and not on which country they invest in, implying that domestic savings could be unrelated to domestic investment under perfect international capital mobility. In such a case, β is expected to be around zero, suggesting that savings in each country move globally in response to international investing opportunities for higher profitability. On the other hand, domestic investment in a given country will be financed by the global pool of capital[1].

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fostering and opening capital markets ever since the 1997 Asian financial crisis.

REFERENCES

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2. Artis MJ, Bayoumi T; Global capital market integration and the current account. In Taylor, M. P. (Ed.), Money and Financial Markets (pp. 297-307). Oxford: Blackwell. 1992.

3. Dooley M, Frankel JA, Mathieson DJ; International capital mobility: What do saving-investment correlations tell us?, International Monetary Fund Staff Papers, 1987; 34:503-530.

4. Feldstein M; Domestic saving and international capital movements in the long run and the short run, European Economic Review, 1983; 21:129-151. 5. Feldstein M, Bachetta P; National saving and

international investment, 201-20. In: Bernheim, B. D., Shoven, J. B. (Eds.), National saving and economic performance, Chicago University Press. 1991.

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