ANALYSIS OF THE DETERMINANTS OF TRADE BALANCE IN DEVELOPING COUNTRIES IN ACCORDANCE WITH MARSHALL-LERNER CONDITION

Abstract

In developing countries, the role of capital flows in balance of payments has increased. Since the trade of goods and services have reached enormous amounts after the financial liberalization, it might be essential to examine the factors determining balance of trade. With the increase of foreign trade, the trade of goods and services among countries increases as well. The importance of exchange rate is at all time high due to the difference in countries' currencies that have commercial and financial relationship. In literature, the condition that supports the positive effect of higher-rate currency movement on trade balance is known as Marshall – Lerner Condition. Such condition claims that an upward trend in rates has a curative effect on trade balance. However, this condition holds only when the addition of the price elasticity of import demand and the price elasticity of export demand equals one or more than one. In this study, apart from the effective exchange rate variable; GDP, direct foreign investment and money supply are included in the model since it is believed that they also have an impact on trade balance. The extent of the effect of all these variables on import-export balance is implied accordingly. Therefore, nine economically-similar European countries are studied and the data of these countries from 2001 to 2015 are empirically tested. The analysis is tested with FGLS Method and it is concluded that Marshall – Lerner Condition does not satisfy any of these nine countries. The Data have been taken from the Worldbank macro economic indicators