The effects of financial liberalization on economic growth case study for ASEAN countries by using KAOPEN index

UNIVERSITY of ECONOMICS ERASMUS UNIVERSITY ROTTERDAM HO CHI MINH City INSTITUTE of SOCIAL STUDIES VIETNAM The NETHERLANDS VIETNAM – NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS The Effects of Financial Liberalization on Economic Growth Case Study for ASEAN Countries By Using of KAOPEN Index BY NGUYEN HUNG MASTER OF ARTS IN DEVELOPMENT ECONOMICS HO CHI MINH CITY, NOV 2016 UNIVERSITY OF ECONOMICS HO CHI MINH CITY ERASMUS UNIVERSITY ROTTERDAM INSTITUTE OF SOCIAL STUDIES VIETNAM THE NETHERLANDS VIETNAM – NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS The Effects of Financial Liberalization on Economic Growth Case Study for ASEAN Countries By Using of KAOPEN Index A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By NGUYEN HUNG Academic Supervisor: Professor, Doctor Nguyen Trong Hoai HO CHI MINH City, November 2016 ii DECLARATION “This is to certify that this thesis entitled “The Effects of Financial Liberalization on Economics Growth Case Study for ASEAN Countries by Using of KAOPEN Index”, which is submitted by me in fulfillment of the requirements for the degree of Master of Art in Development Economics to the Vietnam – The Netherlands Programme (VNP) The thesis constitutes only my original work and due supervision and acknowledgement have been made in the text to all materials used.” Nguyen Hung iii ACKNOWLEGEMENT This thesis has been completed with a great deal of supports and encouragements that I have been receiving from many people To whom I am indebted I owe a debt of gratitude to Professor Nguyen Trong Hoai, my academic super visor, for his invaluable instructions and guidance during my work He has been stimulating my critical thinking skills and guiding me to rethink and to deconstruct my thesis topic Hence, his expertise has helped me very much to compile necessary skills in thinking, writing, and fulfilling this thesis Moreover, he took time to diligently review my final thesis draft and help to correct the errors and the wrong words usages Furthermore, I would like to thank Dr Truong Dang Thuy for his enthusiasm of keeping me in schedule of thesis writing I would like also to thank Dr Pham Khanh Nam and Dr Le Van Chon for their helping in developing concept note, thesis research design, and searching data I must show my gratitude toward all lecturers VNP who have broadened my perspectives and encouraged me to fulfill my knowledge as this program requirements Then, I want to say thanks to VNP officers as well as VNP librarian for their support of good conditions and study materials during the study period Next, I wish to express my thank you to all my friends here at VNP Together we have walked and struggled through this whole treasured journey of learning and shared memorable and priceless moments Last but not least, I am very deeply grateful to my family that is an indispensable element to constitute my achievement iv ABSTRACT This study aims to verify the association between financial liberalization and economic growth in ASEAN countries, by using the annual panel data set from 1990 to 2013 at the country level The regression model is base on the form of growth model and similarly with Bekaert et al (2005) model, in which the ChinnIto index (KAOPEN) serves as proxy for financial liberalization (KAOPEN) is frequently used in recent researches, since it is updated annually, available in Internet, and cover about 180 countries in the world The Fixed effect model (FEM) and random effect model (REM) techniques are used to estimate the effect of financial liberalization on economic growth The result of the regression provides the evidence that financial liberalization have positive effects on economic growth in ASEAN countries, including Viet Nam However, the significant level is not strong in (REM) model, but strong significant in (FEM) This result is also illustrated by the recently integration process of ASEAN The experiment of ASEAN shows that as one form of financial liberalization, FDI have not only brought foreign capital inflows but also the collateral benefit to the host countries Key Words: Financial Liberalization, economic growth, ASEAN, relationship, association, total factor of production (TFP), Foreign Direct Investment (FDI) v ABBREVIATION AEC ASEAN Economic Community APEC The Asia-Pacific Economic Cooperation AREAER Annual Report on Exchange Arrangement and Exchange Restrictions ASEAN the Association of Southeast Asian Nations EU European Union FEM Fixed Effect Model IMF International Monetary Fund GDP Gross Domestic Product GNP Gross National Product OECD the Organization for Economic Co-operation and Development REM Random Effect Model WTO the World Trade Organization vi TABLE OF CONTENTS TABLE OF CONTENTS ………………………………………………………………………………………………… LIST OF TABLES LIST OF FIGURES CHAPTER 1: INTRODUCTION 1.1 Problem statements 1.2 Research objectives 1.3Research questions: 1.4 The scope of study 1.5 Research structure CHAPTER 2: LTERATURE REVIEW 2.1 Theoretical literature 2.1.1 Economic Growth and Growth Theory: 2.1.2 Financial Development 2.1.2.1 Financial Deepening 2.1.2.2 Financial Repression………………………………………………………………………………………… 2.1.2.3 Financial Liberalization …………………………………………………………………………………… 2.1.2.4 Financial Liberalization and Economic Growth………………………………………………… 2.2 Empirical Studies…………………………………………………………………………………………………… 2.3 Chapter Remarks ………………………………………………………………………………………………… CHAPTER 3: RESEARCH METHODOLOGY 3.1 Model Specification 3.2 Measuring Financial liberalization 3.2.1 The IMF’s AREAER 3.2.2 Quinn’s Measure 3.2.3 KAOPEN Measure 3.2.4 KA Measure ……………………………………………………………………………………………………… 3.2.5 SHARE Measure ……………………………………………………………………………………………… 3.3 Endogenous Problem from the relationship between Financial Liberalization and Economic Growth …………………………………………………………………………………………………… 3.3.1 Instrumental Variables …………………………………………………………………………………… 3.4 Measurement of Variables ………………………………………………………………………………… 3.4.1 Dependent variable ………………………………………………………………………………………… 3.4.2 Independent Variables ……………………………………………………………………………………… 3.4.2.1 KAOPEN indicator (kaopen1) ………………………………………………………………………… 3.4.2.2 Log Initial GDP (lgdp90) ………………………………………………………………………………… 3.4.2.3 Government consumption / GDP (gconsume) ……………………………………………… 3.4.2.4 Secondary school enrollment (second) ………………………………………………………… 3.4.2.5 Population growth (pop) ……………………………………………………………………………… 3.4.2.6 Log life expectancy (llife) ……………………………………………………………………………… vii Page viii x xi 1 4 5 6 10 10 11 13 18 23 26 26 30 31 32 34 35 35 36 37 38 39 39 39 40 40 41 41 42 3.4.2.7 Dummy Variables: (dlegal) ……………………………………………………………………………… 3.5 Data collection …………………………………………………………………………………………………… 3.6 Model Specification …………………………………………………………………………………………… 3.7 Chapter Remarks ………………………………………………………………………………………………… 42 44 44 45 CHAPTER 4: RESEARCH RESULTS 4.1 Overview Economic Growth and Financial Liberalization in ASEAN………………………… 4.1.1 Overview the economic growth in ASEAN in the period 1990 – 2013………………… 4.1.2 Foreign Direct Investment (FDI) Inflows into ASEAN…………………………………………… 4.1.3 ASEAN Banking Sector………………………………………………………………………………………… 4.1.4 Capital account openness in ASEAN countries ………………………………………………… 4.2 Descriptive Statistics …………………………………………………………………………………………… 4.3 Model Estimation Result …………………………………………………………………………………… 4.3.1 Result of Test for Panel Data Model ………………………………………………………………… 4.3.2 Discussion on the Research Result …………………………………………………………………… 46 46 46 48 51 53 56 64 65 67 CHAPTER 5: CONCLUSION AND RECOMMENDATION 5.1 Conclusions 5.2 Policy implications 5.3 Research limitations 5.4 Suggestions for Further Research ……………………………………………………… REFERENCES APPENDIX A: PANEL REGRESSION MODEL APPENDIX B: RESULTS OF HAUSMAN TEST 73 73 75 77 77 viii 79 83 85 LIST OF TABLES Table 2.1: The role of financial Liberalization in economic growth ……… 24 Table 3.1: The expected sign of variables in model ……………………… 43 Table 4.1: Summary statistics of Variables used in the regressions ……… 56 Table 4.2: The Correlation on the sample observations …………………… 64 Table 4.3: The results of Hausman Test …………………………………… 65 Table 4.4: The Result of Regression ……………………………………… 66 End ix LIST OF FIGURES Figure 4.1: The average of real GDP growth …………………………………… 47 Figure 4.2: Emerging Asia - FDI inflow, 2000-2013 …………………………… 48 Figure 4.3: FDI in ASEAN-4, Singapore and Viet Nam (value in US$ million) 49 Figure 4.4: FDI in VIETNAM …………………………………………………… 50 Figure 4.5 Domestic credit to private sector by banks (% of GDP)……………… 52 Figure 4.6 Financial liberalization in ASEAN-4, Singapore and Viet Nam …… 54 Figure 4.7 Financial liberalization in some Asia countries and Viet Nam……… 55 Figure 4.8: The scatter diagram for economic growth rate and financial Liberalization………………………………………………………… 58 Figure 4.9: The scatter diagram among dependent variable and financial liberalization variable for each ASEAN country …………………… 59 Figure 4.10: The scatter diagram among dependent variable and control variables 62 End x but this not much confident Government consumption to GDP given the negative sigh (β3 = -0.035, p=0.350), it provides the evidence that increasing Government consumption lead to decreasing in growth rate per capita, but it is not significant In theory, that in some situations lower level of government spending would improve economic growth and in other situations higher levels of government spending would be good impact in the economic When government spending is zero, it is likely that there will be small economic growth since enforcing contracts, protecting property, and constructing infrastructure would be very hard works if there were no government performances In the case of ASEAN countries, as Almekinders et al (2015) suggest that there is high requirement in improving infrastructure in urban communities, and links between production locations and domestic consumption centers to develop the economies For this reason, the need is more government spending in infrastructure development Hence, in this situation government consumption is good for economic growth The true experience is in rich countries the population growth is lower the poor countries It is also correct with the result of this study when it has the negative sigh (β5 = -0.044, p=0.655), but insignificant Furthermore, the true over the world show that in rich countries life expectancy is higher than in poor countries Therefore, the logarithm of life expectancy (llife) entered in the model with the hoped sigh is positive At the result, this is corrected when it has a positive coefficient (β6 = 1.184, p=0.536), proving that long life expectancy is correlated with higher economic growth, but it is insignificant It is true for the most of ASEAN countries, but not true for the case of Viet Nam Although the country is in the group of poorer countries in ASEAN, but Viet Nam has obtained the high life expectancy value that is approximate with degree of Singapore and Brunei, the two richest countries in ASEAN The three countries have the highest “life expectancy” at higher than 75 year olds The last variable, legal origin (dlegal) is dummy variable, it is entered the model as instrument variable, that separate countries to the legal origin This is an exogenous to economic growth and is correlated with financial development The expected sign is 71 explicit that the English legal system performs the good institutions, propitious investment profile for foreign investors and higher investor protection, hence associated with higher economic growth In the result, the (dlegal) has the right sign and positive coefficient, but insignificant (β7 = 0.581, p=0.212) As Bekaert et al (2005) assert that generally, the different from rich or developed countries and the never liberalization countries have some features such as: higher population growth, but lower secondary school enrolment and lower life expectancy Therefore, the secondary school enrollment (second) entered to the model with expected having a positive sign However, in regression result of this study, it has the wrong sigh (β4 = -0.013, p=0.081), this is similar with the result of Bekaert et al (2005) but less strong significant That may be had some changes in the developed countries from the 1960s decade, the associated of secondary school enrollment is not much clear with economic growth, since the level of education has risen in new higher level, as a whole The new higher levels, for example, high school enrollment or tertiary education may be given the positive sign in growth model In briefly, except the secondary school enrollment (second) having the wrong sign, all the control variables have the expected sign coefficient, suggesting that this regression model is corrected to theory of growth model In addition these results of (FEM) model, including the wrong sign of secondary school enrollment variable, are similar in the sign and the significant levels to one of models of Bekaert et al (2005) study This give more confirmed for the accuracy of applying regression model in this study 72 CHAPTER 5: CONCLUSION AND RECOMMENDATION This chapter presents the summarizing of major findings in the study basing on analysis results from previous sections It is also giving the suggestions for policy implications to enhance financial liberalization in ASEAN countries In addition, the study has several limitations which must be overcome in the future studies, through that some suggestions are presented for further studies, and that will present in this chapter 5.1 Conclusions Up to now the controversy between the costs and benefits of financial liberalization has been continuing through the past two decades and continuing in the future This is the most intensely debated topics in recent year as Kose et al (2010) suggested, for this provides the evidences that financial liberalization having the benefits also the harms to economic growth In this study, through the above analysis, the result finding here is a positive and highly statistically significant coefficient, which proves that financial liberalization is associated with economic growth in ASEAN countries Although this study inherits the ideas from Bekaert et al (2005), Quinn & Toyoda (2008), the data sample and proxy for financial liberalization are different from the previous studies This study focus just on ASEAN countries, that have the region’s specific in history, legal, policy and economic conditions are some different from other region in the world Moreover, the updated period covering in 24 years, from 1990 to 2013 Despite the difference in data set, the result is in line with studies of Bekaert et al (2005), Quinn & Toyoda (2008) and more other studies in the main stream literature that support for the hypothesis, in which financial liberalization have positive associated with economic growth Furthermore, the empirical finding here is supported by the experience in the economic growth of ASEAN economies, in which FDI play a pivotal role in contributing to the growth rate of GDP As illustration of growth in ASEAN 73 countries, this studies also emphasizes the collateral benefits of financial liberalization could bring to the economies, for example through one form of financial liberalization that is FDI As aforementioned, FDI Could not only give the foreign resources but also lead to increasing labor productivity, arising standard of living, reducing unemployment, speeding up the progress in fighting poverty Because of the above reasons, the result of this study is also different from the results of the studies that find no evidence in the nexus between financial liberalization and economic growth, such as the studies of Grilli & Ferretti (1995); Rodrik (1998); Kraay (1998) However, there is the need of concerns about the contrary ideas that financial liberalization could lead to financial volatile, or even drive to crisis, as Hellmann et al (2000) and Stiglitz (2000) asserted This is true for the case of ASEAN in Asian financial crisis in 1997, the massive capital out flight from ASEAN collapsing the financial system of Thailand, Indonesia, Malaysia, and more Stiglitz (2000) specially suggested that the countries should pay an attention on the “short-term speculative capital flows”, for this will turn to rush out as quick as like when it rushes in to the countries Short term speculative capital flows with the unstable nature could not provide a basis for investment, but could generate the property bubble, and if impose the restriction on it, the other longer term investment that including FDI are still unaffected Giving more illustration for the conclusion is that this study using KAOPEN index of Chinn & Ito (2007) to proxy for financial liberalization, because it is often used to proxy for financial liberalization recently as Almekinders et al (2015) also used KAOPEN to measure the financial liberalization of ASEAN countries The prominent of KAOPEN that is concentrated in the intensity or the stringency in the restriction policy that could reflect more sophisticated type of restrictions For example, one country is in state of the capital account openness, but at the same time, can impose some restrictions to limit current account transactions, or implement the multi-exchange rate policy, or placing requirement on surrender export proceeds The case may have been similar with Indonesia, Malaysia, the 74 Philippines, and Thailand while implementing the openness on capital account, gathering more FDI inflows, but on the same time, perform or tie up some restriction on current account restriction including giving more verification in export proceeds and service payments To compare with previous studies, such as Bekaert et al (2005), Quinn & Toyoda (2008) using “CAPITAL” of Quinn (1997) to proxy for financial liberalization, in spite of the difference of proxy for financial liberalization, the regression results of this study is similar above other studies in providing evidence that financial liberalization associated with higher economic growth With the used of KAOPEN as proxy for financial liberalization it is likely to be more accurate for the case of ASEAN countries 5.2 Policy Implications Through this study, there are enough evidences to demonstrate the issues that financial liberalization leads to economic growth in ASEAN countries Because of this, to reach the higher economic growth rate targets, the policies that have the tendency of financial liberalization may be applied Moreover, as the member countries of ASEAN Economic Community (AEC), Viet Nam and other ASEAN countries should have the paces forward to more integration into the region and world market, which including process of financial liberalization Hence, the choice is adoption financial liberalization as the trend to develop the economies During the process of financial liberalization, there are some aspects that need to concern As Chinn & Ito (2005) suggested that there are three main channels through this financial liberalization has positive impact to financial development The first effect is this influencing to protection financial market by lightening financial restriction, increasing real interest rate in the competitive market equilibrium (Mckinnon, 75 1973) Second, it improves more portfolio diversification that helps to increase risk sharing The two channels effect that have result in reducing the cost of capital, hence enhance more investments The third is its effects on financial institutions, in that the weak institutions are eliminated by the competition For this reason, it could put a greater pressure on the requirement of financial reform As the above mentions, KAOPEN is created by the mix calculated of four aspects of restriction, such as: (i)imposing varied exchange rates, (ii)putting limited in current account transactions, (iii)imposing restriction on capital account transactions and, (iv)placing requirement in surrender of export proceeds In the light of Chinn & Ito (2005), Chinn & Ito (2007) suggestions as above mentioned, to adopt financial liberalization, a country need to impose some movements as below: Firstly, implements the unique interest rate Secondly, removes restrictions on capital account also current account transactions and thirdly, eliminate requirement in surrender export proceeds Some attentions in practices are that the process of financial liberalization should be conducted, but in smoothly steps to ensuring the drive towards stable macroeconomic policies, strong monetary and financial system and try to keep the process always in controlled To this, need to increase the volume of trade and strengthen the banking sector Chinn & Ito (2005) find that the precondition for capital account liberalization is the liberalization in trade transactions, and precondition for equity market development is the development in the banking sector Kose et al (2006) through several studies summarize the “threshold”, at that a county could yield the benefits of financial liberalization They find many contrary ideas and then, they conclude that when an economy is more open to trade and financial flows, it is likely to be able to tolerate higher levels of volatility This means the “threshold” is no meaningful and apply financial liberalization give more benefits for the nations 76 In addition, according to Stiglitz (2000) suggestion, it is clear that the countries could apply the intervention to restricting on the form of “short-term speculative capital inflows.” At the same time, try to provide a good business environment for foreign direct investment (FDI), because FDI could give the host countries not only resources, but also technologies, accessing to world market and improving human capital In briefly, trade openness and development banking are preconditions for financial liberalization process When adopting financial liberalization a country needs to applying the unique interest rate, removing restrictions on capital account also on current account transactions, and eliminating requirement in surrender export proceeds This process should be smoothly conducted, to ensuring the paces towards stable macroeconomic policies, strong monetary and financial system In addition, “short-term speculative capital inflows” must to reduce or constrain on the one hand, and promoting FDI inflows on the other hand 5.3 Research limitations There may have been several limitations in this research The first concern belong to the variable that proxy for financial liberalization Because there are some indicator could be used and estimated in more than one model to analyzing the relationship between financial liberalization then, the results are more convincing The second problem is the quality of data, for all countries not have sufficient data for all years For example, several variables are lacked of observations in some years, especially measures the secondary school enrollment ratio and government consumption This is scattering missing data that could be remedied by finding in different sources outside World Bank database 77 The third issue roots from the relationship between financial liberalization and financial development This relationship looms large in the studies about financial liberalization However, there is a little mentioning for it in this study 5.4 Suggestions for Further Research From the limitations above, some suggestions maybe given to develop for further researches The first is that there are several indicators proxy for financial liberalization, one could choose one or more that most suitable for the research and the control variables that could be find in some sources Moreover, the research will be more attractive if the researcher pay more concerned about the relationship between financial liberalization and financial 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