File Name: financial development and economic growth new evidence from panel data .zip
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Purpose : The purpose of this paper is to examine the relationship between financial development and economic growth for five major emerging economies: Brazil, Russia, India, China and South BRICS during to using banking sector and stock market development indicators. Next, using generalized method of moment system estimation SYS-GMM , the relationship between financial development and growth is investigated.
The banking sector development indicators used in the study include size of the financial intermediaries, credit to deposit ratio CDR and domestic credit to private sector CPS , whereas the stock market development indicators are value of shares traded and turnover ratio. Also, some macroeconomic control variables such as inflation, exports and the enrolment in secondary education were used.
Findings: The examination of the principal indicators of financial development and macroeconomic variables have shown considerable differences between the selected economies. Results from the dynamic one-step SYS-GMM estimates confirm that in presence of turnover ratio, all the selected banking development indicators such as size of financial intermediaries, CDR and CPS are positively significantly determining economic growth. Similarly, in presence of all the selected banking sector development indicators, value of shares traded is found to be positively significantly associated with economic growth.
However, the same is not true when turnover ratio is regressed in presence of banking sector variables. Overall, the evidence suggests that banking sector development and stock market development indicators are complementary to each other in stimulating economic growth.
Practical implications : A positive association between financial development and growth indicates that the policymakers should take necessary measures toward simultaneous development of both banking sector as well as stock market for inducing growth. Also, most of the existing studies are found in case of developed economies.
This paper tries to fill this void by studying five major emerging economies. Development of an economy requires its financial sector to be developed. And the development of financial sector happens in the process of founding and growth of institutions, instruments and markets that sustain the huge investments and growth which help in reducing poverty.
Accordingly, financial development gives better information about possible profitable investments and promotes optimum allocation of capital. In other words, the emergence of financial institutions helps in curtailing cost of acquiring information and effectively implements contracts and executes transactions.
Also, the expanding financial access inculcates dynamic efficiency in the system by bringing about a structural change through innovation and welfare gain to the entire economy.
Development of financial system may be defined as the development of the size, efficiency and stability of financial markets along with increased access to the financial markets that can have multiple advantages for the economy.
For instance, a well-developed financial market channelizes the savings of an economy to profitable investments Stiglitz and Weiss, ; Diamond, , reduce information cost thereby leading to better capital allocation Greenwood and Jovanovic, and also reduce the cost of corporate governance Bencivenga and Smith, Also, developed financial intermediaries boost the technological innovation through rewards to the entrepreneurs King and Levine, b.
Further, according to Levine , financial systems assist in trading, diversification, hedging and risk amelioration, apart from facilitating transactions of goods and services.
Also, according to Levine , capital accumulation and technological innovation are the paraphernalia between financial development and growth. The allocation of credit through financial system works as a channel between financial and real sectors, which can be used to finance working capital requirements and investment in fixed capital; the former is used to raise production whereas the latter enhances productivity in the real sector Das and Guha- Khasnobis, However, contrary to above, some economists also have a different perception toward the association between financial development and economic growth.
Leading this school of thought, Robinson opined, "finance plays a minor role in economic growth; rather it is driven by growth. Further, Lucas insisted that financial markets play a lesser role in an economy's development. Also, recently Shan opined that Asian economic crisis of further casts' doubt on financial development as a driver of economic growth, as here the financial markets failed to allocate the large inflow of funds into profitable ventures.
Further, the global financial crisis of indicates the failure of financial markets which was mainly driven by subprime mortgage lending. Thus, the failure of the economies in monitoring and regulating the evolving financial markets and inability to keep pace with the financial innovation warrants the prudent and sound development of financial markets which may have serious implication for an economy as a whole.
In this context, it is worth noting that very few studies that have examined the finance and growth relationship in BRICS Brazil, Russia, India, China and South Africa have barely studied the impact of banking sector and stock market development on economic growth separately. Against this backdrop, the present paper endeavors to investigate the relationship between financial development and growth for a panel of five major emerging economies BRICS during to The rest of the paper is organized as follows: Section II presents some principal indicators of financial development and macroeconomic variables of BRICS.
Section III discusses some prominent literature pertaining to financial development and growth. Section IV outlines econometric methodology. Section V discusses empirical findings, and finally summary and conclusion are drawn in Section VI.
Principal indicators of financial development and macroeconomic variables: Brazil, Russia, India, China and South Africa. Figure 1 depicts some principal indicators of financial development and macroeconomic variables of the selected economies during to The principal indicators of financial development used in the study include variables representing both the development of banking sector as well as stock market of an economy.
Banking sector development indicators include:. Economic growth, a macroeconomic variable is measured as per capita income PCI growth Levine, Also, following the existing literature, some macroeconomic control variables used in the study are inflation INF , exports as percentage of GDP and the log of number of enrolment in secondary education of the selected economies.
From Figure 1 , it is observed that the average growth rate of PCI of the selected economies ranged between 1. From Figure 1 , it is observed that the FDP has been increasing since for the selected economies. The average percentage of bank's liquid liabilities to GDP of China is about Similarly, the ratio of commercial bank assets to deposit money bank assets plus central bank assets has increased over the study period.
The average size of the banking sector of South Africa is about The mean CDR of China CPS, another measure of banking sector development, shows that the mean value of the variable for South Africa Next, the examination of the stock market development indicators of the selected economies shows that the mean SS for South Africa is about Further, value of shares traded, a proxy for the stock market liquidity indicates that the mean value of the variable during the study period is about Finally, the mean turnover ratio is found to be highest in China Among the selected control variables, inflation was unexpectedly high for Brazil and Russia in early s which smoothed in subsequent years.
The mean inflation of China is about 4. Next, exports expressed as a ratio of GDP, an indicator of the relative importance of international trade in the economy indicates that the mean value of the variable during the study period is highest in case of Russia Finally, the mean growth of number of enrolments in secondary education is found to be promising in case of India, Brazil and South Africa compared to Russia and China.
Theoretical and analytical framework. The seminal exertion by Schumpeter , Goldsmith , McKinnon and Shaw underscores the relevance of financial development for economic growth for some considerable time. To begin with, Goldsmith sought to investigate first how economic growth leads to changes in financial structure, which is the assortment of financial instruments, intermediaries and markets.
Second, Goldsmith tried to examine the impact of financial development on economic growth. Third, Goldsmith sought to assess whether the structure of a country's financial system influences the rate of economic growth. In other words, does the mixture of financial intermediaries and markets functioning in an economy influence economic development. For the first issue, Goldsmith found that development of economies leads to the evolution of and improvements in the financial system.
Particularly, he stated that banks tend to grow bigger relative to national output along with economic development. For the second issue, Goldsmith was not fully successful in evaluating the nexus between the level of financial development and economic growth. In his work, he took a panel of 35 countries using data prior to and documented a positive correlation between financial development and the level of economic activity, but he refrained clearly from drawing causal interpretations from his graphical analysis.
Thus, Goldsmith always refrained from asserting any causal inference that runs from financial development to economic growth. Finally, for the third issue, because of cross-country data limitations, Goldsmith failed to substantiate much on the association between economic development and the combination of financial intermediaries and markets operating in an economy.
To Goldsmith's second objective which was to establish the nexus between financial development and economic growth, considerable progress has been made to expand the analysis in subsequent research. For example, to begin with, late s and early s, most of the studies attempted to investigate the association between financial development, economic growth and reduction of poverty. Specifically, subsequent literature has embodied additional findings on the finance""growth relationship and engulfs the wider approach on causal association where cross-country, firm-level and industry-level studies suggest that economic growth is positively driven by a developed financial system.
After Goldsmith's work, the subsequent studies can be divided mainly into two categories viz. The main contention of structuralists is the quantity, composition and structure of financial variables that prompt economic growth by mobilization of savings, which in turn increases capital formation leading to economic growth thereby reducing poverty Guha-Khasnobis and Mavrotas, On the other hand, McKinnon , and Shaw lead the financial repressionists, and their hypothesis is popularly referred to as the "McKinnon-Shaw" hypothesis.
They contended that an appropriate rate of return on account of financial liberalization on the real cash balances is a driver of economic growth. The fundamental principle of their hypothesis is that a low or negative real interest rate will dampen savings which will shrink the supply of loanable funds for investment, which will in turn pull back the growth rate. Therefore, the McKinnon""Shaw model states that financial liberalization will amplify competition, induce an increase in savings by raising interest rates and thereby promote investment and consequently promote economic growth.
After the early debate on the relationship between financial development and economic growth, many subsequent empirical studies using recent data have found mixed results with respect to the association of financial development and growth. Also, later some empirical studies attempted to establish a cause and effect relationship between the two and made an attempt to make certain predictions on the basis of the nature of association.
For instance, King and Levine a , using the data for 77 countries over the year period from to , established the presence of statistically significant positive relationship between FDP with growth in real per capita GDP, real per capita capital stock and total productivity, respectively. Also, Beck and Levine further using the generalized method of moments GMM and averaged non-overlapping five year's data from to , for 40 countries establish that the development of bank and stock market sector positively influenced economic growth.
However, very recently, Saci et al. However, it was found that in the presence of stock market development indicators, banking sector development negatively influenced economic growth. Recently, Leitao found a positive correlation of financial development with economic growth for 27 European Union Countries and five BRICS countries between and Again, Adusei using dynamic GMMmodel for 24 selected African countries over the period found a positive relationship between financial development and economic growth.
Further, using pairwise granger causality testing, they supported the evidence of bidirectional causality between financial development and economic growth. With respect to causality between financial development and growth studies like Jung found a bidirectional causality between real and financial variables on the basis of data collected for 56 countries in the postwar period, including 19 developed industrial economies.
Also, King and Levine a find that financial development is not the outcome of economic growth, rather finance leads to growth. Further, Wachtel and Rousseau stated that financial development does Granger-causes growth. Also, Luintel and Khan found bidirectional causality between financial development and economic growth for a sample of ten economies. Similarly, Wolde-Rufael found bidirectional causality between economic growth and each of the financial development variables. However, conversely, Demetriades and Hussein conducting causality analysis found little evidence on the causality flowing from financial development to economic growth.
They note that causality patterns vary across countries. Further, studies like Levine and Zervos have shown that bank loans to private enterprises as a proportion of GDP, stock market turnover ratio and value of shares traded are robust predictors of economic growth, productivity growth and capital accumulation. Also, Bhanumurthy and Singh did not find a long-run equilibrium relationship between bank branches and state domestic product for India.
Finally, Menyah et al. As mentioned before, the nexus between financial development and growth is investigated for a panel of five countries, viz. The economies selected in the panel are largely heterogeneous with respect to their geographical region, culture, political and financial structures leading to high variation in explanatory variables to perform the panel regressions.
The period of analysis is from to which covers mainly an era of liberalization, rapid economic growth and volatile world markets. In the present study, real GDP per capita growth PCI is the dependent variable, a proxy which measures the growth of the selected economies.
Alimi, R. The relationship between financial development and economic growth has been a key study in economics field for a long time. This paper examines the link between financial development and economic growth in 7 Sub-Saharan African countries - Nigeria, South Africa, Lesotho, Malawi, Sierra Leone, Botswana and Kenya, over the period of The study applied both static and dynamic panel data approach, to investigate the relation between financial development and economic growth. The results show that financial development has not led to economic growth in the panel of the selected countries when domestic credit provided by the banking sector is used as a proxy for financial development. The results thus lend support for the independent hypothesis postulates that financial development and economic growth are causally independent. Our study also considered foreign direct investment and interest rate as determinant of growth, but only interest rate suggested positive effect on economic growth.
DOI The aim of the paper is to study finance-economic growth nexus in Poland using a time series approach. We find evidence of the existence of the finance-economic growth link in Poland. The obtained results show that when using the share of households and companies in total credits, the long run empirical relationship in VECM is statistically significant and larger. In the case of Poland, empirical evidence that supports this hypothesis was found, and therefore policymakers and researchers should take bank lending structure into account.
DOI/ssrn; Corpus ID: Financial Development and Economic Growth: New Evidence From Panel Data.
The literature on the relationship between innovation, financial development, and economic growth has attracted growing interest in recent years; however, some authors have investigated this relationship using mainly Granger causality test and focusing specially on European countries. This paper examines the causal relationship between innovation, financial development, and economic growth using panel VAR approach for 27 OECD countries over the period — This methodology has allowed us to analyze the three-way linkages between innovation, financial development, and economic growth. Most importantly, the findings revealed that there is a unidirectional causality from economic growth to financial development.
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