Relationship between financial development and economic growth, panel data analysis of 22 developing countries

UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS RELATIONSHIP BETWEEN FINANCIAL DEVELOPMENT AND ECONOMIC GROWTH: PANEL DATA ANALYSIS OF 22 DEVELOPING COUNTRIES BY TRẦN THỊ THU THỦY MASTER OF ARTS IN DEVELOPMENT ECONOMICS HO CHI MINH CITY, October 2014 UNIVERSITY OF ECONOMICS HO CHI MINH CITY VIETNAM INSTITUTE OF SOCIAL STUDIES THE HAGUE THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS RELATIONSHIP BETWEEN FINANCIAL DEVELOPMENT AND ECONOMIC GROWTH: PANEL DATA ANALYSIS OF 22 DEVELOPING COUNTRIES A thesis submitted in partial fulfillment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS BY TRAN THI THU THUY Academic supervisor Dr NGUYỄN MINH ĐỨC HO CHI MINH CITY, October 2014 i CERTIFICATION I hereby confirm that this thesis, namely “the Relationship between Financial Development and Economic Growth: a panel data analysis of 22 Developing countries” is my own work The work has not, in whole or part, been presented elsewhere for assessment Where material has been used from other sources it has been properly acknowledged and referenced If this statement is untrue I understand that I will have committed an assessment offence I have read the Regulations of Vietnam – Netherlands Programme for M.A In Development Economics and I am aware of the potential consequences of any breach of them Signature: Name: Trần Thị Thu Thủy Date: Ho Chi Minh City, October 2014 ii ACKNOWLEDGEMENT I would like to express my gratitude to Dr Nguyen Minh Duc, the academic supervisor, for his very carefully reading and editing of my thesis His valuable comments and suggestions help me to improve the quality of this thesis throughout my thesis stage Thank to his valuable lectures, guidance and encouragement, I can fully complete this thesis I also would like to extend my thanks to Dr Truong Dang Thuy, other professors, tutors and course co-instructors of Economics University who, through their valuable lectures, tutorials and advices, help me during the courses and my study process Finally, many special thanks and gratefulness are given to my family, my classmates of MDE course 18 and to a number of individuals for their encouragement in many ways that strongly support me during my thesis stage iii CONTENTS Certifications………………………………………………………………………………… i Acknowledment ii Contents……………………………………………………………………………………… iii List of tables………………………………………………………………………………… iv List of figures Abstract……………………………………………………………………………………… vi CHAPTER 1: INTRODUCTION 1.1 Research problem 1.2 Research objectives and research questions 1.3 1.2.1 Research objectives 1.2.2 Research questions Thesis Structure CHAPTER 2: LITERATURE REVIEW 2.1 Theoretical concepts related to economic growth and financial development 2.2 Financial development and economic growth: theoretical literatures 2.3 Literature review and empirical studies 2.3.1 Theoretical framework on the relationship between economic growth and financial development 2.3.2 Empirical studies on financial developmen CHAPTER 3: METHODOLOGY 3.1 General methods 3.1.1 Conceptual framework for the study 3.1.2 Research hypotheses: Research models and econometric methodology 3.2 3.3 Data 3.3.1 Determinants measuring financial developme 3.3.2 Determinants measuring economic growth Research process 3.4 CHAPTER 4: ESTIMATION RESULT ANALYSIS AND DISCUSSION 4.1 Brief information on the dataset 4.2 Regression results and discussion 4.2.1 Impact of economic growth on financial deve 4.2.2 Impact of financial development on economic growth CHAPTER 5: CONCLUSION AND IMPLICATION 5.1 Conclusion 5.2 Policy implications for Vietnam 5.2.1 An overview of the relationship between fina Vietnam 5.2.2 Policy implications for Vietnam Limitations and future research 5.3 5.3.1 Limitations 5.3.2 Suggestion for future research APPENDIX Appendix A…………………………………………………………………………… Appendix B……………………………………………………………………………….79 Appendix C……………………………………………………………………………….84 REFERENCES……………………………………………………………………….………95 iv LIST OF TABLES: Table 1: Summary of empirical studies………………………………………………….… 27 Table 2: Expected signs of variables………………………………………………………… 34 Table 3: Variable Description……………………………………………………………… 37 Table 4: Summary of Variables………………………………………………………………49 Table 5: Descriptive statistics and correlations for selected variables……………………… 53 Table 6: GMM estimation of Economic Growth and Financial Development………… ……56 Table 7: Regression Results of Economic Growth and Financial Development…………… 61 v LIST OF FIGURES Figure 1: The relationship between financial development and economic growth………………………………………………………………… 32 Figure 2: Diagram of the main results……………………………………………………… 66 Figure 3: Gross domestic savings in Vietnam and in Asean countries…………………………………………………………… 68 Figure 4: Annual GDP per capita in Vietnam and in Asean countries…………………………………………………………… 70 Figure 5: Gross domestic saving rates in Vietnam and in Asean countries………………….71 Figure 6: Annual growth of domestic credits in Vietnam…………………………………… 72 and in Asean countries Figure 7: Annual growth of Broad Money supply in Vietnam……………………………… 73 and Asean countries vi ABSTRACT: In recent years, many researchers have taken into account the causal connection between financial development and economic growth due to the important role of financial development in the process of achieving the higher economic growth To investigate the causal relationship between financial development and economic growth in twenty two developing countries in different regions from 1990 to 2011, we apply both Generalized method of moment with instrumental variable approach and Ordinary least square technique to examine how determinants of financial development impact on economic growth and how the determinants of economic growth contribute to develop finance system We find that there is a two-way positive impact between financial development and economic growth in selected developing countries We also find that the variable components such as the ratio of broad money to GDP, the ratio of credit offered by bank to private sector to GDP, the ratio of gross domestic savings to GDP and the ratio of domestic credit to the private sector to GDP play an important role in explaining financial development Furthermore, foreign direct investment, general government consumption and trade openness are important factors in accounting for growth rate of GDP per capita We find out that the EXPORT is significantly negative impact on economic growth This result is consistent with the argument that export specialization in developing countries may not benefit the economic growth Finally, taking the advantage of positive relationship between financial and economic development in developing countries, it is suggested that Vietnam needs to strengthen its financial system in the context of the integration into the world economy Vietnam should provide the right incentives to promote the financial sector that will enable it to have high economic growth Keywords: Financial development, growth, causal relationship APPENDIX C: REGRESSION RESULTS C.1 Declare data to be panel Xtset countrycode year panel variable: countrycode (strongly balanced) time variable: year, 1990 to 2011 delta: unit sort country year by country: gen GDPGRTHLAG1= gdpgrth[_n-1] by country: gen DOMCREDITLAG1 = domcreditgdp[_n-1] by country: gen EG= gdpgrth C.2 Regression results on the impact of Economic growth on financial development C.2.1 Testing for regressor endogeneity ivregress 2sls fd (EG = fdi gov trao GDPGRTHLAG1) m2gdp bankcreditgdp DOMCREDITLAG1 grossdsa, robust Instrumental variables (2SLS) regression - Instrumented: EG Instruments: m2gdp bankcreditgdp DOMCREDITLAG1 grossdsa fdi gov trao GDPGRTHLAG1 estat endogenous Page 84 Tests of endogeneity Ho: variables are exogenous Robust Robust score chi2(1) regression F(1,449) C.2.2 Testing for overidentifation ivregress 2sls fd (EG = fdi gov GDPGRTHLAG1) DOMCREDITLAG1 grossdsa, robust Instrumental variables (2SLS) regression - Instrumented: EG Instruments: m2gdp bankcreditgdp DOMCREDITLAG1 grossdsa fdi gov GDPGRTHLAG1 estat overid Test of overidentifying restrictions: Score chi2(2) C.2.3 Testing for weak instruments reg fd fdi gov trao GDPGRTHLAG1 m2gdp bankcreditgdp DOMCREDITLAG1 grossdsa , robust Linear regression Page 85 - test ( ( ( ( ( ( ( ( 1) 2) 3) 4) 5) 6) 7) 8) fdi = gov = trao = m2gdp = bankcreditgdp grossdsa F( 8, C.2.4 Estimation Results ivreg fd m2gdp bankcreditgdp DOMCREDITLAG1 grossdsa (EG = GDPGRTHLAG1 fdi gov trao),robust Instrumental variables (2SLS) regression - Page 86 - Instrumented: Instruments: EG m2gdp bankcreditgdp DOMCREDITLAG1 grossdsa GDPGRTHLAG1 fdi gov Trao - C.3 Regression result on the impact of financial development on economic growth C.3.1 Testing for regressor endogeneity ivregress 2sls EG (fd = m2gdp bankcreditgdp DOMCREDITLAG1 grossdsa) GDPGRTHLAG1 fdi gov trao, robust Instrumental variables (2SLS) regression - -Instrumented: Instruments: estat endogenous Tests of endogeneity Ho: variables are exogenous Robust score Robust regression F(1,449) C.3.2 Testing for regressor correlation correlate domcreditgdp m2gdp grossdsa bankcreditgdp (obs=480) Page 87 DOMCREDITGDP M2GDP GROSSDSA BANKCREDITGDP C.3.3 Testing for Multicollinearity: regress EG DOMCREDITLAG1 grossdsa m2gdp bankcreditgdp GDPGRTHLAG1 import export gov fdi - - Page 88 Mean VIF | correlate DOMCREDITLAG1 grossdsa m2gdp bankcreditgdp GDPGRTHLAG1 import export gov fdi (obs=456) DOMCREDITLAG1 grossdsa m2gdp DOMCREDITLAG1 GDPGRTHLAG1 import export gov fdi C.3.4 Estimation Results C.3.4.1 We obtain the estimations with IMPORT and EXPORT variables C.3.4.1.1 Impact of Domcreditlag1 on economic growth regress EG DOMCREDITLAG1 import export gov fdi, robust cluster() Linear regression - - C.3.4.1.2 Impact of Bankreditgdp on economic growth regress EG bankcreditgdp import export gov fdi, robust cluster() Linear regression Page 89 - - C.3.4.1.3 Impact of M2gdp on economic growth regress EG Linear regression - C.3.4.1.4 Impact of Grossdsa on economic growth regress EG grossdsa import export gov fdi, robust cluster() Linear regression -g Page 90 export | gov | fdi | _cons | C.3.4.2 We obtain the estimations without IMPORT and EXPORT variables C.3.4.2.1 Impact of Domcreditlag1 on economic growth regress EG DOMCREDITLAG1 gov fdi, robust cluster() Linear regression - C.3.4.2.2 Impact of Bankreditgdp on economic growth regress EG bankcreditgdp gov fdi, robust cluster() Linear regression - ba Page 91 C.3.4.2.3 Impact of M2gdp on economic growth regress EG m2gdp gov fdi, robust cluster() Linear regression - C.3.4.2.4 Impact of Grossdsa on economic growth regress EG grossdsa gov fdi, robust cluster() Linear regression gro Page 92 fdi _cons Page 93 REFERENCES Anwar, S., & Nguyen, L P (2011) Financial development and economic 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DEVELOPMENT AND ECONOMIC GROWTH: PANEL DATA ANALYSIS OF 22 DEVELOPING COUNTRIES A thesis submitted in partial fulfillment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS... hereby confirm that this thesis, namely “the Relationship between Financial Development and Economic Growth: a panel data analysis of 22 Developing countries? ?? is my own work The work has not,... in developing countries (Masten et al., 2008) Investigating the two-way effect of financial development and economic growth, Calderón and Liu (2003) used panel data covering 109 developing and