Openness, financial development, economic growth and environmental quality evidence from developing countries

Openness, financial development, economic growth and environmental quality evidence from developing countries.Openness, financial development, economic growth and environmental quality evidence from developing countries.Openness, financial development, economic growth and environmental quality evidence from developing countries.Openness, financial development, economic growth and environmental quality evidence from developing countries.Openness, financial development, economic growth and environmental quality evidence from developing countries.Openness, financial development, economic growth and environmental quality evidence from developing countries.Openness, financial development, economic growth and environmental quality evidence from developing countries.

-Pham Thi Thuy Diem

OPENNESS, FINANCIAL DEVELOPMENT,

ECONOMIC GROWTH, AND ENVIRONMENTAL QUALITY: EVIDENCE

FROM DEVELOPING COUNTRIES

DOCTOR OF PHILOSOPHY THESIS IN ECONOMICS

Ho Chi Minh City, 2022

-Pham Thi Thuy Diem

OPENNESS, FINANCIAL DEVELOPMENT,

ECONOMIC GROWTH, AND

ENVIRONMENTAL QUALITY: EVIDENCE

FROM DEVELOPING COUNTRIES

Major: Development Economics Code: 9310105

ACADEMIC ADVISOR:

Prof Dr Nguyen Trong Hoai

Ho Chi Minh City, 2022

ABBREVIATIONS

LIST OF TABLES

LIST OF FIGURES

ABSTRACT

CHAPTER 1 - INTRODUCTION 1

1.1.Research problems 1

1.1.1 The impacts of openness on financial development 2

1.1.2 The impact of financial development on economic growth 6

1.1.3 The impact of trade openness on environmental quality 9

1.2.Research objectives 11

1.3.Research contributions 13

1.4.Structure of the thesis 14

CHAPTER 2 - LITERATURE REVIEW 16

2.1.Openness and financial development 16

2.1.1 Impacts of openness on financial development: A theoretical review 16

2.1.2 Impacts of openness on financial development: An empirical review 21

2.1.3 Impacts of openness on financial development: Research hypotheses and a

conceptual framework 30

2.2.Financial development and economic growth 32

2.2.1 Impact of financial development on economic growth: A theoretical review32 2.2.2 Impact of financial development on economic growth: An empirical review35 2.2.3 Impact of financial development on economic growth: Research hypothesis and a conceptual framework 42

2.3 Trade openness and environmental quality 45

2.3.1 Impact of trade openness on environmental quality: A theoretical review 45

2.3.2 Impact of trade openness on environmental quality: An empirical review .49

2.3.3 Impact of trade openness on environmental quality: Research hypothesis and a conceptual framework 55

2.2 An integrated conceptual framework for the links between openness, financial development, economic growth, and environmental quality in developing countries 58

CHAPTER 3 - RESEARCH METHODOLOGY 60

3.1.Methodology 60

3.1.1 The issue of model uncertainty 60

3.1.2 Bayesian model averaging methodology and model uncertainty 60

3.2.Construction of variables 66

3.2.1 Openness, financial development, economic growth, and environmental quality 66

3.2.2 Controlled variables 69

4.1.The impacts of openness on financial development: Evidence from developing

countries 102

4.1.1 Descriptive statistics results 102

4.1.2 Estimation results and discussions 107

4.2.The impact of financial development on economic growth: Evidence from developing countries 115

4.2.1 Descriptive statistics results 115

4.2.2 Estimation results and discussions 120

4.3.The impact of trade openness on environmental quality: Evidence from developing countries 126

4.3.1 Descriptive statistics results 126

4.3.2 Estimation results and discussions 131

CHAPTER 5 - CONCLUSIONS 140

5.1.Main findings 140

5.1.1 The impacts of openness on financial development: Evidence from developing countries 140

5.1.2 The impact of financial development on economic growth: Evidence from developing countries 141

5.1.3 The impact of trade openness on environmental quality: Evidence from developing countries 143

5.2.Policy implications 144

5.3.Overall conclusions, limitations, and further research of the thesis 148

5.3.1 Overall conclusions 148

5.3.2 Contributions 149

5.3.3 Limitations and further research 151

REFERENCE 154

APPENDICES 181

I declare that the thesis has been composed by myself and that the thesis hasnot been submitted for any other degree or professional qualification I confirm thatthe thesis submitted is my own, except where thesis which has formed part ofjointly authored publications has been included My contribution and those of theother authors to this thesis have been explicitly indicated below I confirm thatappropriate credit has been given within this thesis where reference has been made

to the work of others

Some works demonstrated in Chapter 1, Chapter 2, Chapter 3, Chapter 4, andChapter 5 were previously published in an international journal, Cogent Economics

& Finance, 9(1) as “Impacts of openness on financial development in developing countries: Using a Bayesian model averaging approach” by Pham Thi Thuy Diem

(the first and corresponding author) & Nguyen Trong Hoai (co-author) (2021) Therest of works demonstrated in Chapter 1, Chapter 2, Chapter 3, Chapter 4, andChapter 5 can be combined into two papers for further publications

The work presented in Chapter 2 was previously published in three nationalpublications including: (i) Tạp chí Phát triển & Hội Nhập, 55(65), 109-116 as

“Financial development and economic growth: A review of the literature” by Pham

Thi Thuy Diem (the first and corresponding author) & Nguyen Trong Hoai

(co-author) (2020); (ii) Tạp chí Công Thương, Số 1-Tháng 1/2021, 72-80 as “Trade openness and environmental quality: A review of the literature” by Pham Thi Thuy

Diem (the first and corresponding author) & Nguyen Trong Hoai (co-author)(2021);

(iii) Review of Finance, 4(1), 9-12 as “Impacts of openness

on financial development: A review of the literature” by Pham Thi Thuy Diem (the

first and corresponding author) & Nguyen Trong Hoai (co-author) (2021)

The thesis has been done under the supervision of Professor Nguyen TrongHoai, the University of Economics Ho Chi Minh City.

Pham Thi Thuy Diem

10 July 2022

TABLE OF CONTENTS COVER PAGE

COMMITMENTS

TABLE OF CONTENTS

ABBREVIATIONS

LIST OF TABLES

LIST OF FIGURES

ABSTRACT

CHAPTER 1 - INTRODUCTION 1

1.1 Research problems 1

The impacts of openness on financial development 2

The impact of financial development on economic growth 6

The impact of trade openness on environmental quality 9

1.2 Research objectives 11

1.3 Research contributions 13

1.4 Structure of the thesis 14

CHAPTER 2 - LITERATURE REVIEW 16

2.1 Openness and financial development 16

2.1.1 Impacts of openness on financial development: A theoretical review 16

2.1.2 Impacts of openness on financial development: An empirical review 21

2.1.3 Impacts of openness on financial development: Research hypotheses and

a conceptual framework 30

2.2 Financial development and economic growth 32

2.2.1 Impact of financial development on economic growth: A theoretical

review 32

2.2.2 Impact of financial development on economic growth: An empirical

review 35

2.2.3 Impact of financial development on economic growth: Research

hypothesis and a conceptual framework 42

2.3 Trade openness and environmental quality 45

2.3.1 Impact of trade openness on environmental quality: A theoretical review

45

2.3.2 Impact of trade openness on environmental quality: An empirical review 49

2.3.3 Impact of trade openness on environmental quality: Research hypothesis

and a conceptual framework 55

2.2 An integrated conceptual framework for the links between openness, financial development, economic growth, and environmental quality in developing countries .58

CHAPTER 3 - RESEARCH METHODOLOGY 60

3.1 Methodology 60

The issue of model uncertainty 60

Bayesian model averaging methodology and model uncertainty 60

3.2 Construction of variables 66

3.2.1 Openness, financial development, economic growth, and environmental

quality 66

3.2.2 Controlled variables 69

3.3 Data sources 99

CHAPTER 4 - OPENNESS, FINANCIAL DEVELOPMENT, ECONOMIC GROWTH AND ENVIRONMENTAL QUALITY - EVIDENCE FROM

DEVELOPING COUNTRIES 102

4.1 The impacts of openness on financial development: Evidence from developing countries 102

4.1.1 Descriptive statistics results 102

4.1.2 Estimation results and discussions 107

4.2 The impact of financial development on economic growth: Evidence from developing countries 115

4.2.1 Descriptive statistics results 115

4.2.2 Estimation results and discussions 120

4.3 The impact of trade openness on environmental quality: Evidence from developing countries 126

4.3.1 Descriptive statistics results 126

4.3.2 Estimation results and discussions 131

CHAPTER 5 - CONCLUSIONS 140

5.1 Main findings 140

The impacts of openness on financial development: Evidence from developing countries 140

The impact of financial development on economic growth: Evidence

fromdeveloping countries 141

5.1.3 The impact of trade openness on environmental quality: Evidence from

developing countries 143

5.2 Policy implications 144

5.3 Overall conclusions, limitations, and further research of the thesis 148

5.3.1 Overall conclusions 148

5.3.2 Contributions 149

5.3.3 Limitations and further research 151

REFERENCE 154

APPENDICES 181

AREAER Annual report on Exchange Arrangements and Exchange Restrictions

KAOPEN Capital account openness index

TradeOpen Trade openness

UNCTAD United Nations Conference on Trade and Development

LIST OF TABLES

Table 4.1 Summary statistics of the variables for Objective 1, whole sample, 64

Table 4.2 Correlations between of the variables for Objective 1, whole sample,

Table 4.3 The impacts of openness on financial development: posterior

Table 4.4 Summary statistics of the variables for Objective 2, whole sample, 64

Table 4.5 Correlations between of the variables for Objective 2, whole sample,

Table 4.6 The impacts of financial development on economic growth: posterior

Table 4.7 Summary statistics of the variables for Objective 3, whole sample, 64

Table 4.8 Correlations between of the variables for Objective 3, whole sample,

Table 4.9 The impacts of trade openness on environmental quality: posterior

LIST OF FIGURES

Figure 1.1 Financial development in developing countries over the period

Figure 1.2 Openness in developing countries over the period 2003-2017 5

Figure 1.3 Economic growth in developing countries over the period 2003-

Figure 1.4 Environmental quality in developing countries over the period

Figure 2.2 A theoretical approach to openness and financial development 21

Figure 2.3 A conceptual framework for the impacts of openness on financial

Figure 2.6 A theoretical approach to trade openness and environmental quality 47

Figure 2.7 A conceptual framework for the impact of trade openness on

Figure 2.8 An integrated conceptual framework for three objectives 59

Figure 4.1 Scatter plots of openness and financial development in developing

Figure 4.2 Marginal densities of trade openness, financial openness, and the

interaction between trade openness and financial openness from BRIC 111

Figure 4.4 Scatter plots of financial development and economic growth in

Figure 4.7 Scatter plots of trade openness and environmental quality in

Motivated by trade and financial liberalisation policies have becomeincreasingly important in developing countries over the past two decades and theexisting gaps in the literature regarding financial development, economic growth,and environmental quality research need to be addressed Therefore, this thesis aims

to provide new evidence on the impacts of trade and financial openness on financialdevelopment, the impact of financial development on economic growth, and theimpact of trade openness on environmental quality in 64 developing countries overthe period 2003-2017 One major contribution of this thesis for three objectives isthe adoption of the regression model based on Bayesian model averaging approach

to consider model uncertainty (Raftery et al., 1997; Hoeting et, al., 1999; Chipman

et al., 2001; Fragoso et al., 2018)

Regarding the impacts of openness on financial development, the thesisdemonstrates that the contribution of trade openness to financial development isimportant in developing economies with better institutions However, financialopenness has an insignificant positive effect on financial development There is noevidence to support the Rajan and Zingales hypothesis that the simultaneousopenness to both trade and capital flows promotes financial development Thefindings also indicate that a better institutions environment allows a developingeconomy to exploit the benefits of openness to financial development

Regarding the impact of financial development on economic growth, themain findings indicate that financial development has a significant U-shaped effect

on economic growth, providing new insight concerning the relationship betweenfinancial development and economic growth in developing countries The resultsalso demonstrate that investment to gross domestic product ratio and foreign directinvestment have significant positive effects on economic growth, whereaspopulation growth has a significant negative impact on economic growth

With regard to the impact of trade openness on environmental quality, theempirical results reveal that trade openness in developing countries does not causeenvironmental degradation Besides trade openness, the findings provide strongevidence in favour of financial openness and renewable energy consumption as two

of the most important determinants of environmental quality by reducing carbondioxide emissions Meanwhile, inward FDI stock to domestic capital stock andincome have harmful effects on environmental quality in the context of developingcountries

Keywords: Openness, financial development, economic growth,

environmental quality, developing countries, Bayesian model averaging

CHAPTER 1 - INTRODUCTION1.1 Research problems

It is now widely accepted that trade and financial openness constitutepotentially important mechanisms for financial development (Rajan and Zingales,2003; Baltagi et al., 2007, 2009; Chinn and Ito, 2002, 2006; Law and Demetriades,2006; David et al., 2014; Svaleryd and Vlachos, 2002, 2005; etc.) which in turn caninfluence economic growth, especially in developing countries (Caporale et al.,2014; Estrada et al., 2010, 2015; Menyah et al., 2014; Calderón and Liu, 2003;Bittencourt, 2012; Law and Singh, 2014; Rioja and Valev, 2004a, b) Regardingtrade openness, it could be one of the most crucial factors explaining environmentalquality (Antweiler et al., 2001; Cole and Elliott, 2003; Managi et al., 2009; Atici,

2009, 2012; Baek et al., 2009; Nasir and Rehman, 2011; Shahbaz et al., 2016;Mutascu, 2018)

Although there have been numerous investigations attempting to understandfinancial development, growth and environmental quality research, the majority ofstudies only utilised methodologies for panel data basing on traditional statisticalinference (Gries et al., 2009; Chinn & Ito, 2002; Cecchetti & Kharroubi, 2012;Estrada et al., 2015; Zhang et al., 2012; Ergungor, 2008; Adu et al., 2013; Frankel

& Rose, 2005; Antweiler et al., 2001; Cole & Elliott, 2003; Le et al., 2016) Thestandard statistical approaches ignore model uncertainty, leading to over-confidentinferences, “all-or-nothing” constraint, and omitted variable bias that generalizepoorly (Raftery, 1993; Raftery et al., 1997, 2005; Hoeting et al., 1999; Chipman etal., 2001; Fragoso et al., 2018, Hinne et al., 2020) Moreover, the competitivetheories and empirical studies have remarkably emerged from the literature onfinancial development, growth and environmental quality determinants, whichposes a significant challenge for development economics Therefore, Bayesianmodel averaging (BMA) is a tailor- made approach to deal with the modeluncertainty that surrounds the large set of candidate regressors In this thesis, theadoption of BMA proposed by several seminal

works, such as Raftery (1993), Raftery et al (2005), Raftery et al (1997), andHoeting et al (1999), can make significant contributions at bridge the methodology.Besides, previous findings are not conclusive; hence financial development,economic growth, and environmental quality studies have been highly controversial

in development economics

The impacts of openness on financial development

Regarding the impacts of openness on financial development, the seminalwork of Rajan and Zingales (2003) argue that, for genuine financial development, acombined liberalisation of both trade and capital accounts are a necessary condition(the simultaneous openness henceforth); this is the simultaneous opennesshypothesis on financial development According to Rajan and Zingales (2003),interest groups (incumbents) are often against financial development because itgenerates stronger competition that erodes their rents They argue thatcontemporaneous opening of both the trade and capital flows will reduceincumbents’ powers, hence enhancing financial development Moreover, throughnew opportunities, trade and financial openness might bring sufficient new profitsthat exceed the negative effects of competition In contrast, McKinnon (1991)suggests that trade liberalisation should precede financial liberalisation to promotefinancial development, especially in developing countries The simultaneousopenness hypothesis of Rajan and Zingales (2003), as well as the empirical work ofBaltagi et al (2009) is one of the most important ideas for motivating this thesis.The empirical studies for the relationships between openness and financialdevelopment are mixed and have not achieved a unique consensus across developedand developing economies that can be drawn: positive (Beck, 2002; Chinn and Ito,2002; Rajan and Zingales, 2003; Braun and Raddatz, 2005; Law and Demetriades,2006; Baltagi et al., 2007, 2009; Wolde- Rufael, 2009, David et al., 2014; Karimuand Marbuah, 2017); negative or mixed (Svaleryd and Vlachos, 2002; Aizenmanand Noy, 2003; Aizenman, 2004; Do and Levchenko, 2004, 2007; Ito, 2006; Chinnand Ito, 2006; Svaleryd and Vlachos, 2005;

Kim et al., 2010a; Kim et al., 2010b; Trabelsi and Cherif, 2017), null effects(Wolde- Rufael, 2009; Gries et al., 2009; Hauner et al., 2013) The thesis focuses ondeveloping countries where there were relatively few works from this perspective.

Trade and financial liberalisation have marked in the past two decades,especially in developing countries At the turn of the 1980s, some internationalorganisations, including International Monetary Fund, World Bank, and WorldTrade Organisation, have commonly imposed structural adjustment policies ondeveloping countries (Goldberg & Pavcnik, 2007) Free-market programs weregoverned by reduction of trade barriers, deregulation, and privatisation whilefinancial liberalisation policies were regulated by removing financial repressionsuch as the interest rate ceilings, administrative credit allocation, high reserverequirements, and other government-induced distortions With respect to financialdevelopment, there have been remarkable differences between developing countriesand developed ones in financial development, measured by the ratio of privatecredit to GDP in the past two decades Financial development in developingcountries has been increasing steadily during this period, but it has been graduallystagnating in developed economies especially from 2009 (Figure 1.1) In contrast,the trends in trade openness and financial openness have become moreunpredictable compared with financial development in developing countries (Figure1.2) Accordingly, this thesis seeks to examine whether or not trade openness andfinancial openness have important roles in the financial development process indeveloping countries in the light of the inconclusive results of previous studies.Moreover, understanding the causes underlying financial development is crucialbecause it allows countries, especially developing ones, to encourage banking sectoractivities and this can affect economic growth

Figure 1.1 Financial development in developing countries over the period

2003-2017

Source: Global Financial Development Database (GFDD) and author’s calculations

Developing countriesDeveloped countries

Figure 1.2 Openness in developing countries over the period 2003-2017

Source: World Development Indicators (WDI), Annual report on Exchange Arrangements and Exchange Restrictions (AREAER),

Chinn and Ito (2019) and author’s calculations

Developi

ng countries

Develop

ed countries

0, 00 1

-2003 2004 2005 2006 2007 2008

2009 2010 2011 2012 2013 2014

2015 2016 2017

0, 00 0

0, 00 1

0, 00 1

0, 00 2

0, 00 2

0, 00 3

Financi

al openness

Developing countriesDeveloped countries

This thesis contributes to the empirical literature on openness and financialdevelopment in six aspects Firstly, the thesis uses a BMA approach suggested byseveral seminal works such as Raftery (1993), Raftery et al (2005), Raftery et al.(1997), Hoeting et al (1999), etc to consider model uncertainty This approach has notbeen used before in investigating the impacts of openness on financial development;therefore, the present thesis aims at filling this gap in the econometrics literature.Secondly, as there are several controversies that surround the measurement of financialdevelopment, this thesis uses the ratio of private credit to GDP to capture the state offinancial development, due to its being often taken as the most suitable indicator fordeveloping countries (Beck et al., 2007; Ito, 2006) Thirdly, there is a persistentscarcity of empirical works on the impacts of openness on financial development fordeveloping countries using the legal origins variable as an important determinant of itsprotection of corporate shareholders and creditors in a financial system Fourthly, thethesis utilises a variety of the interactions between trade openness with other variablesincluding financial openness, institutional quality, and real GDP per capita to capturethe different channels through which trade liberalisation can affect financialdevelopment Fifth, the regional dummy variables are included in the regressions ascontrol variables to compare levels of financial development across regions Finally,due to data availability, data for the period 2003 – 2017 are adequate for maximisingthe number of collected developing countries to investigate the impacts of openness onfinancial development; hence, this thesis obtains the optimal sample size comparedwith previous studies focusing on developing countries.

The impact of financial development on economic growth

The relationship between financial development and economic growth hastraditionally been a central issue in development economics research over the past fewdecades (Andersen & Tarp, 2003; Chinn & Ito, 2002; Estrada et al., 2015; King &

Levine, 1993a; Levine et al., 2000; Menyah et al., 2014) Most empirical studiesconclude that financial systems influence savings and investment decisions, leading toeconomic growth in both developed and developing countries (Levine, 2004; Zhuang etal., 2009) Specifically, Levine (2005, p 869) suggests that the overall functions offinancial systems include the reduction of information, enforcement, and transactioncosts through five channels of (i) producing information ex-ante regarding possibleinvestments and allocation of capital; (ii) monitoring investments and corporategovernance following financial provision; (iii) facilitating the trade, diversification, andmanagement of risk; (iv) mobilizing and pooling savings; and (v) easing the exchange

of goods and services Financial system efficiency refers to the effective performance

of the five basic functions, and financial development implies an improvement infinancial systems’ efficiency

Figure 1.3 Economic growth in developing countries over the period 2003-2017

Source: World Development Indicators (WDI) and author’s calculations

Over the last two decades, developing economies have experienced a wave of financial sector reforms facilitated by the elimination of government restrictions on the

Developing countriesDeveloped countries

financial system in terms of interest rates, high reserve requirements, and quantitativerestrictions on credit allocation to promote economic growth (McKinnon, 1973; Shaw,1973) However, economic growth in developing economies has been unsteady,suffering reversals at certain times during the 2003–2017 period Relatively rapideconomic growth was experienced during 2003–2007, a period of relatively highfinancial development Economic growth suddenly decreased during 2007–2009,dramatically reversing in 2009, followed by stagnation in economic growth thatprevailed from the latter period 2010–2017 (Figure 1.3) This thesis aims to providenew evidence on the impact of financial development on economic growth indeveloping countries over the period 2003–2017.

This investigation extends the literature in six respects First, research on therelationship between financial development and economic growth that considersopenness factors (trade and financial openness) has received considerably lessattention, particularly for developing countries The present thesis aims to close thisgap in the literature by investigating whether and how economic growth is influenced

by financial development and openness in developing countries Second, previousempirical studies primarily focus on panel data methods based on traditional orfrequentist statistics, whereas no studies examine the impact of financial development

on economic growth using approaches based on Bayesian statistics To fill this gap,this thesis applies the Bayesian model averaging (BMA) approach proposed by severalseminal studies, such as Raftery (1993), Raftery et al (2005), Raftery et al (1997), andHoeting et al (1999), to consider model uncertainty Third, there are severalcontroversies regarding the measurement of financial development The ratio of privatecredit to gross domestic product (GDP) is widely used as a proxy for financialdevelopment (Beck et al., 2007; Ito, 2006) and has often been assumed as the mostsuitable indicator for the characteristics of developing countries Fourth, there is apersistent scarcity of empirical studies on the impact of financial development oneconomic growth for developing

economies examining legal origins variables as an important determinant of theprotection of corporate shareholders and creditors in a financial system Fifth, the thesisemploys a variety of the interactions between trade openness with other variables,including financial openness and institutional quality, to capture different channelsthrough which trade liberalisation might influence economic growth Finally, regionaldummy variables are included in the regressions as control variables to compare thelevels of economic growth across regions.

The impact of trade openness on environmental quality

International trade could be one of the most crucial factors explainingenvironmental quality (Antweiler et al., 2001; Liddle, 2001; Atici, 2009, 2012;Mutascu, 2018; Shahbaz et al., 2016; etc.) Trade increases the size of the economyleading to an increase in pollution, and hence trade, ceteris paribus, is the principalcause of environmental degradation (Harrison, 1995; Rock, 1996; Tobey, 1990).However, Birdsall and Wheeler (1993), Lee and Roland-Holst (1997), and Jones andManuelli (1995) suggest that environmental damage linked to trade is not caused bytrade Due to the scale effect (through an increase of the size of the economyoriginating from increased trade volume), environmental quality could decline, therebyincreasing pollution However, trade could enhance the environmental quality via thetechnique effect and/or composition effect (i.e., as trade increases, income leading toenvironmental regulation and supervision is tightened) The production of pollution-intensive goods in one nation causes environmental pollution while increasing in othernations through international trade This composition effect is attributed to two relatedhypotheses: the displacement hypothesis and the pollution haven hypothesis The twohypotheses are associated with the contribution of the composition effect.Fundamentally, there is no difference between these two hypotheses regardingcomparative advantage in international trade Given that trade relates one country with

international communities, an underdeveloped economy could rely on technologytransfer via foreign direct investment (FDI), which may reduce environmentalpollution Therefore, free trade has contradictory influences on environmental quality,both positive and negative.

Figure 1.4 Environmental quality in developing countries over the period

2003-2017

Source: World Development Indicators (WDI) and author’s calculations

Over the last two decades, the increasing greenhouse gases emissions are a keythreat of global warming, and the current ongoing climate change has been a crucialconcern to all societies from developed to developing countries Figure 1.4 shows thatCO2 emissions (metric tons per capita) in developed countries are significantly higherthan in developing countries Overall, there were steep upward trends in the CO2emissions per capita in developing countries during the period 2003-2017, while thisindicator of developed countries went down significantly

Developing countriesDeveloped countries

This thesis differs from Antweiler et al (2001), Cole and Elliott (2003), Managi

et al (2009) in several aspects Firstly, research on the effects of trade openness onenvironmental quality under considering financial openness has received less attention,especially for developing economies Hence, this thesis aims to close this gap byexamining whether and how both trade openness and financial openness in developingeconomies influence environmental quality Secondly, this thesis employs the BMAapproach to consider model uncertainty Several seminal studies, such as Raftery(1993), Raftery et al (2005), Raftery et al (1997), Hoeting et al (1999), etc., proposedthis approach This approach has not been utilised before to investigate the effects oftrade openness on environmental quality; therefore, this thesis aims at filling this gap inthe econometrics literature Thirdly, renewable energy consumption is considered amajor determinant of environmental quality because it influences environmentalquality through various favourable ways (Jebli et al., 2016; Zafar et al., 2020; Bilgili et

al 2016; Sebri & Ben-Salha, 2014; Shafiei & Salim, 2014) Fourthly, there is apersistent scarcity of empirical studies on the effects of trade openness onenvironmental quality for developing economies using legal origins variables Thesevariables are employed as key determinants of CO2 emissions via the shaping ofgovernance mechanisms, leading to overall institutional logic that governshuman behaviour Finally, regional dummy variables are included in theregressions as control variables to compare the levels of environmental quality acrossregions

1.2 Research objectives

Motivated by the beneficials role of trade and financial openness increasing indemand for financial services and the size of markets (Svaleryd and Vlachos, 2002;Thorsten Beck, 2002), reducing incumbents’ powers (Rajan and Zingales, 2003), moretransparent via the price mechanism in market for loanable funds (McKinnon andShaw, 1973), and reducing or increasing environmental pollutants (Antweiler et al.,2001;

Liddle, 2001; Cole and Elliott, 2003; Mutascu, 2018; Shahbaz et al., 2016), trade andfinancial openness might influence financial development, economic growth, andenvironmental quality in developing countries Therefore, this thesis aims to providenew evidence on the impacts of trade and financial openness on financial development,the impact of financial development on economic growth, and the impact of tradeopenness on environmental quality To achieve the overall objective, specificobjectives are as follows:

First objective: Investigating the impacts of openness on financial development

in developing countries over the period 2003-2017 (Objective 1 henceforth).

Based on the several gaps mentioned in Section 1.1.1 regarding Objective 1, thethesis also considers other controlled factors which have not been investigated before

as follows:

(i) Investigating the impacts of interactions between trade openness with

financial openness, institutional quality, and real GDP per capita on financial development in developing countries

(ii) Investigating the impacts of regional dummy variables on financial

development in developing countries (iii) Investigating the impacts of legal origins on financial development in

developing countries

Second objective: Investigating the impact of financial development on

economic growth in developing countries over the period 2003-2017 (Objective 2 henceforth).

Based on the several gaps mentioned in Section 1.1.2 regarding Objective 2, thethesis also considers other controlled factors which have not been examined before asfollows:

(i) Investigating the impacts of interactions between trade openness with

financial openness and institutional quality on economic growth in developing countries

(ii) Investigating the impacts of regional dummy variables on economic

growth in developing countries (iii) Investigating the impacts of legal origins on economic growth in

developing countries

Third objective: Investigating the impact of trade openness on environmental

quality in developing countries over the period 2003-2017 (Objective 3 henceforth).

Based on the several gaps mentioned in Section 1.1.3 regarding Objective 3, thethesis also considers other controlled factors which have not been analysed before asfollows:

(i) Investigating the impact of financial openness on environmental quality

in developing countries (ii) Investigating the impact of renewable energy consumption

on environmental quality in developing countries (iii) Investigating the impacts of legal origins on environmental quality in

developing countries (iv) Investigating the impacts of regional dummy variables on environmental

quality in developing countries

1.3 Research contributions

One of the first major contribution of the thesis was the adoption of theregression model based on the BMA approach proposed by Fernandez et al (2001b) toconsider model uncertainty in financial development, growth and environmentalquality research in the context of developing countries The second is to provide acomprehensive of

relevant issues, three conceptual frameworks for three objectives and an integratedconceptual framework, which have not been documented before, with a focus onquantifying the impacts of trade and financial openness on financial development, theimpact of financial development on economic growth, and the impact of trade openness

on environmental quality The third is to provide no substantial evidence in favor of thesimultaneous openness to both trade and capital flows as a crucial determinant offinancial development and economic growth in developing countries The fourth is toprovide a new understanding into the relationship between finance and economicgrowth as a U-shaped curve in the context of developing countries The fifth is toprovide new evidence on the impacts of legal origins on financial development,economic growth, and environmental quality, respectively The sixth is to provide newevidence on the impact of renewable energy consumption on environmental qualitywhich has not been considered in Antweiler et al (2001), Cole and Elliott (2003),Managi et al (2009) The finally is to suggest key policy implications related tofinancial development, economic growth, and environmental quality in developingcountries

1.4 Structure of the thesis

The structure of the thesis is as follows:

Chapter 1: This chapter presents research problems, research objectives,research contributions, and structure of the thesis

Chapter 2: This chapter reviews theoretical and empirical studies relating tothree research objectives, including: (i) the impacts of openness on financialdevelopment; (ii) the impact of financial development on economic growth; (iii) theimpact of trade openness on environmental quality In addition, this chapter alsoprovides the theoretical and conceptual frameworks, and hypotheses

Chapter 3: This chapter includes the research methodology of the thesis,construction of variables, and data source relating to three research objectives.

Chapter 4: This chapter provides the descriptive statistics summaries and BMAresults of three research objectives including: (i) the impacts of openness on financialdevelopment in 64 developing countries over the period 2003-2017; (ii) the impact offinancial development on economic growth in 64 developing countries over the period2003-2017; (iii) the impact of trade openness on environmental quality in 64developing countries over the period 2003-2017

Chapter 5: This chapter summarises some of the main findings in the thesis,explains policy implications, contributions, limitations, and suggestions for furtherresearch

CHAPTER 2 - LITERATURE REVIEW2.1 Openness and financial development

2.1.1 Impacts of openness on financial development: A theoretical review

Firstly, regarding financial openness, several theoretical and empiricalarguments are in favor of financial openness inspired by the seminal contribution ofMcKinnon (1973) and Shaw (1973) (hereinafter called McKinnon-Shaw hypothesis).The McKinnon–Shaw hypothesis does not support the policies of financial repression,including the interest rate ceilings, administrative credit allocation, high reserverequirements, and other government-induced distortions in which these policies were

so widespread during the 1960s and 1970s in less developed countries

Figure 2.1 The McKinnon–Shaw model

less developed countries, it is also indicated that the real rate r would be held below itsequilibrium level by causing an administratively determined nominal interest rate Thesecond circumstance is mentioned in terms of financial repression that a fixed interest

interest rate such as r3

not allowed or, in other words, the institutional ceilings are set

up in deposits), but non-price rationing in loanable funds must also enforcecompliance Thus, in this situation, two key consequences emerge: Firstly, the level ofsavings remains at a low rate and so does the level of investment due to savings play aprimary role in determining the real supply of credit; secondly, there exists aninefficiently allocation of investable funds via non-price criteria Consequently, it isthen argued that both properties prevent the growth and developing of the financialsystem as well as the overall economy

When a higher institutional nominal interest rate is considered, the relaxation ofthe degree of financial repression brings the expected beneficial effects on savings, forexample, leads to a rise in a real interest rate equal to r1 Consequently, several low-

yielding investments that were previously financed will be eliminated by thismechanism, hence improving the average efficiency of investment In the secondcircumstance, the rate of economic growth is enhanced, and the savings function isshifted to S(g1 ) At the new investment rate, actual investment I1 , would be higher

than in the former circumstance due to increased savings within it can be seen clearly

those economies This will bring positive consequences for a higher economic growththrough increased savings, loanable funds as well as a more efficient allocation of these

2 as depicted in Figure 2.1 The circumstance in which themarket for loanable funds would be transparent via the price mechanism.

Secondly, with respect to trade openness, the seminal work of Beck (2002)provides how’s a theoretical model of free trade and financial development The modelfocuses on the role of financial development in promoting large-scale, savings-mobilising, and high-return enterprises Because a greater level of external financeallows for the use of scale economies, good producers with higher returns to scaleprofit from a higher degree of financial development than other good producers Ineconomies with a more developed financial system, this leads to increased productionand a better trade balance of this good in overall output (Helpman, 1981; Khan, 2001)

In equilibrium for the closed economy, Beck (2002) suggests that “the share ofentrepreneurs in manufacturing decreases in the search costs for financialintermediaries” In the food industry, lower search costs result in a lower return toentrepreneurs than in the manufacturing industry Because manufacturingentrepreneurs may take advantage of scale efficiencies, they can earn more from alarger level of external financing Furthermore, food producers profit from a largerdebt-to-capital ratio, rather than from the higher level of capital stock As a result,financial development linked to decreased search costs would shift productionincentives in favor of manufacturing items produced by a larger manufacturing sector

In order to maintain the open economy's equilibrium, Beck (2002) states that “If,everything else equal, the domestic financial intermediaries

contributes to a technological advantage in the manufacturing production, therebyhaving a manufacturing comparative advantage.

Thirdly, besides the McKinnon-Shaw hypothesis and the theoretical model ofBeck (2002) in terms of financial development and international trade, there are alsotwo main direct channels through which openness may affect financial developmentare via increasing in demand for financial services and the size of markets Svalerydand Vlachos (2002) demonstrated that an increase in trade openness creates demand fornew products in the financial services sector, e.g., trade finance instruments, hedging ofrisks, etc Furthermore, capital account openness can decrease the cost of capital andincrease liquidity, hence may lead to higher financial development Levine (2001)fined some evidence that the liquidity of the stock market may be improved byabolishing restrictions imposed on international portfolio flows

Fourthly, another important channel through which openness may influencefinancial development is via political economy factors According to Rajan andZingales (2003), interest groups (incumbents) against financial development because itensures it generates stronger competition that erodes their rents They argue thatsimultaneous opening of the trade and capital flows (hereinafter called thesimultaneous openness hypothesis) will reduce incumbents’ powers, hence enhancingfinancial development Moreover, though the new opportunities, trade and financialopenness might bring the sufficient new profits that exceed the negative effects ofcompetition

Thirdly, several studies show a positive relationship between openness,institutions, and financial development Kose et al (2009) prove that capital accountliberalisation may force discipline on macroeconomic policies because it increases the