puzzles in financial development and economic growth

Puzzles in Financial Development and Economic Growth

ByBinam Ghimire

Liverpool John Moores University, Liverpool, U.K.

Motivation – People’s Well-being (1)

Binam Ghimire, Liverpool John Moores University

Flag Source: http://borgenproject.org/Pictures.html Source : Baier et al (2003)

An American born 2000 AD 1850 AD

Life expectation 77 Years 40 Years

Reach age 1 after birth 99.4% 85%

EducationAbove high

schoolStay in school -

only 3 years

Work life starts at the age 20 Years 9 years

http://images.google.co.uk/imgres?imgurl=http://205.234.253.9/~artther/images/darkflower%20screensize.jpg&imgrefurl=http://205.234.253.9/~artther/&h=800&w=585&sz=101&hl=en&start=9&tbnid=xpM6l0wehCQ3PM:&tbnh=143&tbnw=105&prev=/images?q=dark+blue+flower&svnum=10&hl=en&sa=G


Source: http://borgenproject.org/Pictures.html

“Growth can spare people en masse from poverty and drudgery.”

-Nobel Laureate, Michael Spence (2008)

Motivation – People’s Well-being (2)



19621964

19661968

19701972

19741976

19781980

19821984

19861988

19901992

19941996

19982000

20022004

20062008

-4

-2

0

2

4

6

8

10

East Asia & Pacific Sub-Saharan Africa Euro area

Growth variation across regions

Real GDP per capita growth in %

Motivation – Growth varies (1)



19631965

19671969

19711973

19751977

19791981

19831985

19871989

19911993

19951997

19992001

20032005

20070

200000000000

400000000000

600000000000

800000000000

1000000000000

1200000000000

Korea, Rep.

Nigeria

Current GDP, in US Dollars Billion

Motivation – Growth varies (2)



Economic miracles in 13 countries*:

- 7% p.a. or higher growth

- 25 years (or longer)

*List of countries:Botswana, Brazil, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, Malta, Oman, Singapore, Taiwan, China, and Thailand

No silver bullets but one of the common ingredients : - High rates of Savings and Investments

Motivation – The Miracles


http://www.growthcommission.org/index.php

Financial Institutions (B

anks and Markets)

Savings Mobilization

Information Cost

Resource (capital) Allocation

Market Frictions

Corporate Control

Transaction Cost

Facilitate Risk Management

Efficient trading of goods, services and contracts

due to productivity growth / technological

change etc. (Demirgüç-Kunt and Maksimovic,

1998, Rajan and Zingales, 1998,

Schumpeter, 1912)

Growth of Firms leading to economic

growth


Finance and Growth – Theoretical Link


Finance and Growth – The Literature (1)


“developments in finance enabled the industrial revolution”

- Walter Bagehot (1873)

“where enterprise leads finance follows”- Joan Robinson (1952)




Mixed reactions and ambiguities in finance and growth relationship (see for example, De Gregorio and Guidotti 1995, Xu 2000, Deidda and Fattouh 2002)

Detail survey in Driffill 2003, Fitzgerald, 2006, Trew 2006



“although conclusions must be stated hesitantly and with ample qualifications, the preponderance of theoretical reasoning and empirical evidence suggests a positive first-order relationship between financial development and economic growth.” -Ross Levine (1997, p. 688 and 2005)




Finance and Growth – The Puzzles

1st Puzzle : Finding that banks have a positive effect upon economic growth in the long run but a negative one in the short run. (Beck and Levine 2004, Loayza and Rancière, 2006 )

2nd Puzzle : Positive effect of stock markets upon economic growth irrespective of time horizons. (Atje and Jovanovic, 1993, Shen and Lee, 2006, Saci et al. 2009.



Papers Sample Period Sample Size (Years)

Sample Size (Countries)

No. of LDCs in Sample

Atje and Zovanovic(1993) 1960-1985 26 40 Non

Demirgüç-Kunt and Levine (1996) 1986-1993 8 41 Non

Levine and Zervos(1998) 1976-1993 18 47 1 (Bangladesh)

Zhu et al. (2004) 1976-1993 18 47 1 (Bangladesh)

Beck and Levine(2004) 1976-1998 23 40 1 (Bangladesh)

Rioja and Valev (2004) 1976- 1995 20 40 Not provided

Shen and Lee(2006) 1976-2001 26 48 Non

Li (2006) 1978-1997 20 33 Non

Saci et al.(2009) 1988-2001 14 30 1 (Bangladesh)

Finance and Growth :Possible sample Biasness

Papers on finance and growth relationship involving banks and stock market and nature of their sample:


Banks and Exchange in LDCs


31 without a stock exchange

3 without a central bank

Banks established 28 years before central bank

Exchange (where they exist) established after five decades

of commercial banks and nearly three decades after

central banks



Estimation - VariablesVariables Definition

GROWTH Real GDP per capita growth rate

PRIVATE CREDIT Ratio of private sector credit issued by bank and non bank financial institutions to GDP

CAPITALISATION Ratio of market price of share multiplied by number of shares divided by GDP

VALUE TRADED Ratio of product of number of shares traded and the market price of such shares to GDP

TURNOVER Ratio of value of the trading of shares on domestic exchanges divided by total value of listed shares

GOVERNMENT CONSUMPTION

Ratio of general government consumption expenditure to GDP

CAPITAL FORMATION Ratio of gross capital formation to GDPTRADE OPENNESS Trade as percentage of GDPINFLATION Change in consumer price index

EDUCATIONTotal secondary enrolment, regardless of age, to the population of the age group that officially corresponds to that level of education

INITIAL INCOME The current GDP per capita in US Dollars of the start year cummulatively increased by the US inflation rate

BLACK MARKET PREMIUM The difference rate between black market exchange rate and the official rate

LEGAL ORIGIN DUMMIES "1" for true and "0" for false where 1 implies countries following legal system of a particular country

BANK CREDIT ALL SECTORRatio of credit issued by bank and non bank financial institutions (to all sector except central government) to GDP



Estimation - Sample Data

Sample period: 1970 – 2006

Countries: 92 developing and developed and 28 LDCs

Possibly the Largest sample in the literature on finance and growth involving banks and exchange.

(Note: This work argues that the sources have mistakenly mentioned “data not available” for bank or stock market related variables for those periods when the institutions in the countries did not exist.)


Estimation Techniques


Testing for stationarity in Panel: LLC, 2002

Estimation Techniques in application

POLS – Fixed Effect Individual and TimeTSLS – Endogeniety problemGMM – Dynamic Panel Two step GMM


The Results


1st Puzzle:

Short run: Negative relationship with banks development (support to literature)

Long run: Negative relationship with banks development (does not support literature)

2nd Puzzle:

Sign depends on variables chosen, the method of estimation and the possible role of self-selection bias


Private credit Vs. Credit all sector (1)


19811983

19851987

19891991

19931995

19971999

20012003

20050

0.20.40.60.8

11.21.41.61.8

19811983

19851987

19891991

19931995

19971999

20012003

20050.3

0.4

0.5

0.6

0.7

0.8

0.9

1

19811983

19851987

19891991

19931995

19971999

20012003

20050

0.5

1

1.5

2

2.5

Hong Kong

U.K. Finland

19911993

19951997

19992001

20032005

0.8

1

1.2

1.4

1.6

1.8

2

Canada

Note: Dashed line PRIVATE CREDIT and solid line BANK CREDIT ALL SECTOR



Sierra Leone

Brazil Kenya

19921994

19961998

20002002

20042006

0

0.2

0.4

0.6

0.8

1

19821984

19861988

19901992

19941996

19982000

20022004

20060

0.10.20.30.40.50.60.7

19811983

19851987

19891991

19931995

19971999

20012003

20050

0.10.20.30.40.50.60.70.8

19941995

19961997

19981999

20002001

20022003

20042005

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

Zambia

Note: Dashed line PRIVATE CREDIT and solid line BANK CREDIT ALL SECTOR

Private credit Vs. Credit all sector (2)



The Results with inefficient variable

1st Puzzle:

Short run: Negative relationship with banks development (support to literature)

Long run: Positive relationship with banks development (support to literature)


Conclusion


Atje and Jovanovic (1993) surprise quote (we should establish exchanges for growth which is not happening) repeated

The Puzzles: The results are different for banks and stock markets and again different over long and short runs

The results support relationship in the long run only with inefficient variable (Credit All Sector).

Puzzles are in need of further research


Thank you


All works cited above have been fully acknowledged in the paper. List of references will be made available upon request.

Thank You!


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